Health-care mutual funds may be on the mend.
After turning in a relatively weak performance last year, funds devoted to pharmaceuticals, biotechnology and other medical stocks were one of the few fund categories sporting a gain through the end of January. The average health-care fund was up about 10.59 percent, according to Lipper Inc. That sure beats the average U.S. stock fund, which was down 1.08 percent for the same period.
Health-care funds were laid low in 1999 by various worries, including growing talk in Washington of a Medicare drug benefit that could lead to pricing pressures on big drug makers. Other concerns: federal budget cuts pummeling the hospital-management sector and mounting class-action litigation against health-maintenance organizations.
These concerns haven’t gone away, and, of course, this is a presidential election year, so talk will be plentiful of health-care reform that could hurt big pharmaceuticals stocks in particular. But the health-care sector does have one thing in its favor now: As technology stocks race toward ever-higher valuations, health-care companies don’t look as sick as they did last year to many professional stock pickers dizzy from being in nosebleed valuation territory.
“When tech stocks roll over, companies with more certain business prospects will do well, and health-care companies fit right into that category,” says John Rekenthaler, research director at fund tracker Morningstar Inc.
“It’s time for these stocks to participate in the bull market again,” echoes Mike Gaffney, manager of Pimco Opportunity Fund, a portfolio with a wide investing mandate that recently boosted its exposure to health care to 20 percent from 18 percent at the end of 1999.
And Gaffney clearly isn’t alone: Health-care shares now represent about 22.5 percent of the typical stock mutual fund, up from 15.9 percent a year ago, according to Morningstar. “Money is flowing back into health care,” says Gaffney.
Health-care mutual funds marginally trailed behind the Standard & Poor’s 500 stock index in 1999, returning 19.15 percent, compared with the S&P 500’s 21.04 percent gain. But during the past few months, the funds have been fueled by a rally in biotech stocks, which began last year when some biotech companies unveiled blockbuster new drugs.
Dresdner RCM Biotechnology Fund is up 56.14 percent year to date through Feb. 10, while Franklin Biotechnology Discovery Fund is up 44.72 percent, according to fund tracker Lipper Inc.
Mainstream health-care funds, which buy biotech as well as other health-care companies, aren’t up as strongly but are still beating the broader market. The sector’s biggest fund, $10 billion-in-assets Vanguard Health Care Fund, is up 6.63 percent, and Putnam Health Sciences Fund, the second-largest health-care mutual fund at $5.5 billion, is up more than 12 percent. Meanwhile, the S&P 500, including reinvested dividends, is off 3.45 percent in the same period.
To some market observers, the improved health of the health-care sector is long overdue. Health-care mutual funds have historically performed as well as tech mutual funds. In a 10-year period that ended in late 1998, health-care funds produced an average annual return of 22.79 percent a year, marginally behind the average annual return of 23.62 percent for tech specialty funds.
But the relationship changed last year when health care faltered and investors began pushing tech shares skyward. By the end of 1999, the average tech fund sported a 29.91 percent annualized gain for the decade, compared with the typical health-care fund’s 18.37 percent advance. The big decline in the 10-year average annualized gain is also largely attributable to removing 1989, when the average health-care fund rose 46.33 percent.
“It seems to me right now that the more timely stocks to own are stocks that would be a little less volatile and have not gone up as much,” says Drew Cupps, manager of Strong Enterprise Fund. He recently cut back on tech in favor of health-care shares, such as hospital-management companies Tenet Healthcare Corp. and Columbia HCA/Healthcare Corp. “The risk-reward in health care has improved a fair amount versus tech,” he adds.
Investors shouldn’t leap willy-nilly into the health-care fund sector, however. Like tech mutual funds, health-care funds come with many different stripes. Some encompass all areas of health care, from pharmaceutical companies to medical-equipment makers. Others focus on specific subsectors. Fidelity, for instance, runs funds devoted to such concentrated areas as biotech, medical equipment, medical delivery and hospital management.
An investor’s first instinct might be to jump into a biotech fund, given this subsector’s feverish year-to-date performance. But Morningstar’s Rekenthaler cautions that biotech is notoriously volatile. “Biotech has got the word `tech’ in its name for a good reason,” he says. “Biotech rises on the same dream as tech stocks, and they will likely crash with tech stocks.”
Moreover, some Wall Street analysts caution that biotech powerhouses Amgen Inc. and Biogen Inc. face lower earnings growth this year, with fewer blockbuster products expected. In late January, Amgen reported strong fourth-quarter earnings growth but warned of slower growth ahead.
A more stable alternative: health-care funds of a more general nature. Invesco Health Sciences Fund, for instance, recently had about 47 percent of its assets in big drug makers, 34 percent in biotech and 9 percent in medical-equipment and device makers. Invesco is up 13.46 percent this year through Feb. 10. according to Lipper.
“A fund with a more diversified charter can take advantage of a better-performing sector at any one time,” says Kris Jenner, a health-care analyst at T. Rowe Price Associates. “A fund with a restrictive charter is at the mercy of whether or not its sector does well.”
Richard England, manager of Putnam Health Sciences Fund, says he expects health-care stocks in general to perform better this year, especially as many investors rotate out of tech stocks. “At the start of 1999, health-care stocks were expensive, but we come into this year with the stocks pretty cheap,” he says. “There’s plenty of potential for things to break health care’s way. The momentum is in our favor.”
Still, there are caveats. John Schroer, manager of Invesco Health Sciences Fund, cites the possibility of health-care reform rearing its ugly head as part of the presidential race. But he is crossing his fingers. “We think there might be a relief rally coming up for health-care stocks,” he says.
