VHT - FHLC: Aging U.S. Demographics Should Boost This Health Care ETF

2023-03-29 16:33:39 ET

Summary

• Healthcare is considered a defensive sector that should outperform during times of high inflation, weak economic growth, and challenging markets.
• In addition, demographics should be a tailwind as the U.S. population is aging, and going forward, that trend is only accelerating.
• Since its inception in October of 2013, the FHLC ETF has delivered an average annual total return of 12.4%. The expense fee is 0.08% and the fund is rated 4-stars.
• Top holdings include UnitedHealth Group, J&J, AbbVie, Merck, and Eli Lilly.

My followers know that I advise investors to build a well-diversified portfolio and to hold it throughout the market's up-and-down cycles in order to receive the returns the market is more than willing to give to them. Part of my portfolio strategy includes thematic ETFs some of which - like the Fidelity MSCI Health Care ETF ( FHLC ) and the SPDR Consumer Staples ETF ( XLP ) - are relatively defensive in nature and are intended to buoy my portfolio in times of market duress and high-inflation while still generating strong long-term total returns. Indeed, both of these ETFs have outperformed the S&P 500 - as represented by the Vanguard S&P 500 ETF ( VOO ) - over the past year and during the 2022 bear-market (see graphic below). However, the FHLC ETF did not do as well as I expected. That being the case, today I'll take a closer look at the fund to see if it is actually achieving my overall long-term goals and if it is well-positioned to benefit from a U.S. population that is rather rapidly aging.

Investment Thesis

The HealthCare Sector is considered to be "defensive" and relatively recession resistant because - in general - consumers continue spending on healthcare related goods-and-services no matter how the economy if performing and because the sector can typically pass inflation costs right on through to consumers and providers.

Meantime, there is a strong demographic tailwind for the HealthCare Sector because the population in the U.S. is aging and older people obviously need more healthcare. As shown in the graphic below, the Urban Institute estimates :

The number of Americans ages 65 and older will more than double over the next 40 years, reaching 80 million in 2040. The number of adults ages 85 and older, the group most often needing help with basic personal care, will nearly quadruple between 2000 and 2040.

With that as background information, let's take a closer look at the FHLC ETF to see how it has positioned investors for success going forward.

Top-10 Holdings

As shown in the graphic below, which was taken directly from the Fidelity FHLC ETF webpage (where you can find more detailed information on the fund), the top-10 holdings equate to what I consider to be a relatively concentrated 46% of the entire portfolio:

I say "relatively concentrated" because the fund holds a large number of companies: 439.

UnitedHealth Group ( UNH ) is the #1 holding with an 8.0% weight. UNH is a diversified health care company that operates in the United States. The company offers consumer-oriented health benefit plans and services for Federal employers, public sector employers, small businesses, and individuals. The company also offers health care coverage and Medicare/Medicaid plans and well-being services for individuals age 50 and up. Somewhat surprisingly, UNH stock is down 8.3% over the past year and currently trades with a forward P/E of 19x.

The #2 holding with a 7.2% weight is Johnson & Johnson ( JNJ ). In January, JNJ reported Q4 earnings that were a beat , but revenue of $23.7 billion (-4.4% yoy) was $200 million shy of analysts' expectations. As the chart below shows, JNJ has been a huge disappointment for the FHLC ETF since the start of 2022 and is down a whopping 14.6% YTD:

Big-pharma has a large allocation in FHLC's top-10 list with drug companies like AbbVie ( ABBV ), Merck ( MRK ), Eli Lilly ( LLY ), Pfizer ( PFE ), and Bristol Myers Squibb ( BMY ) equating to - in aggregate - 20.9% of the entire portfolio. These pharmaceutical companies are typically decent dividend payers, and yield 3.74%, 2.77%, 1.34%, 4.10%, and 3.34%, respectively.

However, note that FHLC's 30-day SEC yield is only 1.42%. That being the case, the primary investment objective with the FHLC ETF is long-term capital appreciation, not income.

Abbott Labs ( ABT ) is the #8 holding with a 3.2% weight. Abbot is yet another big disappointment given its prior history of delivering strong shareholder returns. The stock is down 18.6% over the past year as a baby formula shortage and a roll-off of pandemic related sales have been two big headwinds that investors have decided to run from (see Abbott Labs: Prepare For A Tough 2023 ).

Performance

As mentioned earlier, the FHLC fund, from inception, has a relatively solid 12.4% average annual return:

However, as can be seen from the first chart above, FHLC has been struggling over the past year because some of its top-holdings have severely under-performed.

The chart below compares FHLC ETF's 5-year total returns performance with some competing ETFs, including: the Vanguard Health Care ETF ( VHT ), the SPDR HealthCare Sector ETF ( XLV ), and the iShares US Health Care ETF ( IYH ). I also added the broad market averages as represented by the VOO ETF, the DJIA ETF ( DIA ), and the Nasdaq-100 Trust ( QQQ ):

Note that, despite the 2022 bear-market mauling of the technology sector, the QQQ's win by a large margin, with the ( XLV ) ETF coming in second place and beating the FHLC ETF by 6.4% while also outperforming the S&P 500 and DJIA by significant margins.

Risks

The FHLC ETF is not immune to the headwinds of the macro-economy: high-inflation, higher interest rates, and continuing impacts of the pandemic which the planet was still recovering from before the horrific invasion of Ukraine effectively broke the global energy & food supply-chains.

Political risks abound. The Democrats want to make prescription drugs more affordable, while the Republicans would like to cut Medicare and Medicaid benefits.

I also don't understand the need for the FHLC fund to hold 439 companies.

Summary & Conclusion

The FHLC ETF has been a recent and relative disappointment for me given its large allocation to companies that have struggled much more than one would have thought given the overall challenging economy, market, and inflation backdrop. Some of those struggles have to do with pandemic related spending roll-off, but some of it was due to self-inflicted wounds by individual companies (i.e. baby formula drama in the case of ABT and talc lawsuits in the case of JNJ). Hopefully these are short-term challenges that these companies will overcome because the aging demographics discussed earlier is a compelling long-term tailwind for the HealthCare Sector.

I'll give the FHLC ETF a HOLD rating, but note that the XLV ETF is outperforming and holds only 65 stocks. However, XLV has an expense fee of 0.10% - 2 basis points higher than FHLC. XLV appears to be well-worth the extra expense.

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