Healthcare Funds: Worthy Investment Or Risky Business?

The healthcare industry is a complex and ever-evolving sector, encompassing a diverse range of companies and services. From pharmaceutical giants to medical device manufacturers, the healthcare sector offers a multitude of investment opportunities. With advancements in technology and an ageing population, the demand for healthcare products and services is expected to increase, presenting potential growth prospects for investors. However, it is essential to approach healthcare investments with a comprehensive understanding of the industry's dynamics and potential risks, such as regulatory changes and patent expirations. In this article, we will delve into the intricacies of investing in the healthcare sector, exploring the different investment avenues, key trends, and potential pitfalls to navigate.

The pros of investing in healthcare funds

There are several pros to investing in healthcare funds. Here are some key advantages:

Long-term growth potential

The healthcare industry has demonstrated resilience during economic downturns, as the demand for healthcare products and services tends to remain stable or increase. This was evident during the COVID-19 pandemic, when healthcare companies, particularly those in vaccine development, diagnostics, and telehealth, experienced significant growth and adaptability. With an ageing population and ongoing technological advancements, the healthcare sector is expected to continue growing.

Defensive stocks

Healthcare stocks are often considered defensive stocks, as they tend to perform well or experience less severe declines during market downturns. This is because people still require basic healthcare products and services, such as medication, doctor visits, and emergency care, even when consumer spending is down. As a result, healthcare stocks can help investors minimise risk through diversification.

Growth and diversification

The healthcare sector is one of the fastest-growing sectors, driven by an ageing population and advancements in medical technology. With the Baby Boom generation, born between 1946 and 1964, now in their 50s to 70s, there is an increased demand for healthcare products and services. This demographic trend is expected to continue driving growth and stability for investors in the healthcare sector.

Recession resistance

While no sector is completely recession-proof, healthcare stocks tend to hold up better than most during economic recessions. A study from the National Bureau of Economic Research found that healthcare hiring remained stable or even increased during periods of economic downturn. This makes healthcare funds an attractive option for investors seeking more stable investments.

Dividends and cash flow

Many healthcare companies, particularly established providers, insurers, and biotech and pharmaceutical firms, generate substantial cash flows. These companies often pay dividends to their shareholders, and some have a long history of steadily increasing their dividend payouts. This can be an attractive source of income for investors.

The cons of investing in healthcare funds

Investing in healthcare can be a lucrative option, but it is not without its drawbacks. Here are some of the cons of investing in healthcare funds:

Regulatory and Political Changes

The healthcare industry is heavily regulated, and changes in government policies and regulations can significantly impact healthcare companies. For example, the implementation of a possible future single-payer system could affect the profitability of healthcare providers and insurers. Additionally, political changes, such as shifts in party control of the government, can also influence the performance of healthcare stocks.

Patent Expirations and Competition

Pharmaceutical and biotech companies rely heavily on patents to protect their intellectual property. When patents expire, these companies face competition from generic drug manufacturers, which can impact their bottom line. The entry of generic drugs into the market can result in a significant decline in sales and profitability for the original patent holder.

High-Deductible Requirements

Investing in healthcare often involves high-deductible health plans (HDHPs). While HDHPs offer lower premiums, they require individuals to pay higher out-of-pocket expenses before insurance coverage kicks in. This can be a financial burden, especially for those with frequent or unexpected medical needs. Meeting the high deductible may be challenging, and some individuals may delay seeking healthcare to avoid spending money from their HSA accounts.

Fluctuating Stock Prices

Healthcare stocks can be volatile due to various factors. Clinical trial results, regulatory changes, and surprises in clinical-trial data can cause significant swings in stock prices. Positive surprises, such as better-than-expected data or faster time to market, can lead to stock appreciation, while negative surprises can have the opposite effect. Therefore, active monitoring and a good understanding of the industry are crucial for investors.

Record-Keeping and Regulatory Requirements

Health savings accounts (HSAs) come with certain regulatory filing requirements, such as contribution rules, specific withdrawal guidelines, and distribution reporting. This can create a record-keeping burden for individuals, who must maintain proper documentation and receipts for qualified health expenses, especially if they are audited by the IRS.

Fees and Charges

Some HSAs charge monthly maintenance fees or per-transaction fees, which can vary by institution. While these fees are typically not very high, they can, in some cases, exceed the interest earned on the account, impacting the overall balance. It is important to carefully review the fee structure of any HSA before opening an account.

The risks of investing in healthcare funds

The healthcare sector is a broad and diverse industry, encompassing hospitals, pharmaceuticals, biotechnology, medical devices, insurance companies, and more. While investing in healthcare can be a smart move for those seeking long-term growth, there are several risks that investors should be aware of. Here are some of the key risks associated with investing in healthcare funds:

Regulatory Changes

The healthcare industry is heavily regulated, and changes in government policies and regulations can significantly impact healthcare companies. For example, reforms such as the implementation of a single-payer system or the Affordable Care Act can reshape the sector and affect companies' profitability. Additionally, the success of pharmaceutical, biotech, and medical device companies relies heavily on obtaining approval from regulatory bodies like the FDA. Failure to secure approvals can doom experimental companies in these fields.

Patent Expirations

Pharmaceutical and biotech companies depend on patents to protect their intellectual property. When patents expire, these companies face competition from generic drug manufacturers, which can significantly impact their bottom line and stock prices.

Market Competition

The healthcare industry is highly competitive, with numerous companies vying for market share. This competition can lead to price wars and decreased profits for businesses in the sector.

Clinical Trial Outcomes

The value of stocks in pharmaceutical and biotech companies is heavily influenced by clinical trial outcomes. Positive surprises, such as better-than-expected results or faster time to market, can cause stocks to surge. Conversely, negative surprises or delays in clinical trials can have the opposite effect, leading to significant declines in stock prices.

Political Risk

Healthcare is a highly politicized sector, and changes in government can bring about policy shifts that affect the industry. For example, the debate around universal healthcare and proposals such as Medicare for All could lead to reforms that reshape the industry.

Reimbursement Trends

Negative trends related to reimbursement can impact investments in the healthcare sector. Changes in reimbursement policies or issues with insurance companies can affect the profitability of healthcare providers and other businesses in the sector.

Underwriting Skills

The profitability of health insurance companies heavily depends on their underwriting skills. Ineffective underwriting can lead to higher medical costs relative to the premiums received, impacting their financial performance.

In conclusion, while investing in healthcare funds can offer attractive growth prospects, it is crucial for investors to carefully consider and monitor these risks. Conducting thorough research and assessing one's risk tolerance is essential before making any investment decisions in the healthcare sector.

The best healthcare funds to invest in

Investing in healthcare can be a smart move for those looking for long-term growth potential in their portfolio. The healthcare industry has proven resilient, even in times of economic downturn, as the demand for healthcare products and services tends to remain relatively stable.

There are several types of healthcare funds to consider, each with its own advantages and risks. Here are some of the best healthcare funds to invest in, divided by category:

Exchange-Traded Funds (ETFs)

ETFs offer exposure to a diversified portfolio of healthcare companies, reducing the volatility of investing in individual stocks. They are a good option for those seeking a more hands-off approach to investing in the healthcare sector. Here are some of the top healthcare ETFs:

• Vanguard Health Care Fund: With $42.77 billion in total assets, this fund seeks long-term capital appreciation by investing in a diversified portfolio of health sciences companies worldwide.
• Live Oak Health Sciences Fund: This fund, with $51.09 million in total assets, focuses on investing in companies engaged in the research, development, and production of healthcare-related products and services.

Mutual Funds

Mutual funds are actively managed, allowing investors to benefit from the expertise of fund managers in selecting healthcare stocks. They are a good option for those seeking a more hands-on approach while still maintaining diversification. Here are some of the top healthcare mutual funds:

• Schwab Health Care Fund (SWHFX): With $744.73 million in total assets, this fund aims for long-term capital growth by investing in a diversified group of healthcare companies, including pharmaceutical and biotechnology firms, as well as medical product manufacturers.
• Fidelity Select Medical Technology and Devices Portfolio (FSMEX): Managed by Edward Yoon, this fund has $7.6 billion in assets and focuses on investing in companies engaged in the research, development, and manufacture of medical equipment and devices, as well as related technologies.
• T. Rowe Price Health Sciences (PRHSX): With $15.5 billion in assets, this fund consistently outperforms its peers by overweighting more aggressive areas of the healthcare sector, such as biotechnology.

Individual Stocks

Investing in individual healthcare stocks can be riskier, as they are more susceptible to fluctuations due to regulatory changes and clinical trial results. However, it can also offer potentially higher rewards. Here are some options to consider:

• Johnson & Johnson: A diversified healthcare company with a long history of steady growth and a solid dividend.
• Moderna: A biotech company that gained prominence during the COVID-19 pandemic for its mRNA vaccine, and has a promising pipeline of drugs in development.
• GlaxoSmithKline: A global healthcare company with a diverse portfolio, including pharmaceuticals, vaccines, and consumer healthcare products. They played a significant role in the COVID-19 response.

It is important to note that investing in healthcare, like any other sector, carries risks. These include regulatory changes, patent expirations, and clinical trial outcomes. Conduct thorough research, assess your risk tolerance, and consider seeking financial advice before making any investment decisions.

The different types of healthcare funds

The healthcare sector is vast and varied, with many different types of funds to invest in. Here are some of the main types of healthcare funds:

Exchange-Traded Funds (ETFs)

ETFs are a popular way to invest in healthcare as they offer a diversified portfolio of healthcare companies, reducing the volatility of investing in individual stocks. They are a good option for those seeking exposure to a range of companies in the sector.

Mutual Funds

Similar to ETFs, mutual funds invest in a variety of healthcare companies, but may offer more hands-on management. These funds can provide diversified exposure to a range of companies serving the healthcare sector, including pharmaceutical and medical device makers, HMOs, hospitals, and nursing homes. Some funds may focus on just one industry segment, such as service providers or biotechnology firms.

Individual Stocks

Investing in individual healthcare stocks can be riskier but potentially more rewarding. This option allows investors to focus on specific companies or industries within the healthcare sector, such as pharmaceutical, biotechnology, or medical device companies.

Biotech Companies

Biotech companies focus on developing new drugs and medical treatments, and they can be a high-risk, high-reward investment option. These companies often spend a significant percentage of their revenue on research and development, and their stock prices can be greatly affected by clinical trial data and regulatory changes.

Medical Device Companies

Investing in medical device companies can be a way to gain exposure to the healthcare industry without investing directly in pharmaceuticals. These companies manufacture a range of medical products, from bandages to artificial joints and heart stents, and they can be subject to similar clinical trial paths and regulatory environments as drug manufacturers.

Frequently asked questions