XLV - Health Care Select Sector Fund ETF: Riding The Healthcare Boom

2023-10-16 14:56:57 ET

Summary

• The Health Care Select Sector SPDR Fund is an ETF that tracks the performance of the U.S. health care sector.
• XLV has a diverse portfolio of holdings, including well-known companies like Eli Lilly, UnitedHealth Group, and Johnson & Johnson.
• The ETF's performance has been hurt by slowing demand for Covid-related treatments, but it has performed closely to similar healthcare ETFs.

Overview

The Health Care Select Sector SPDR Fund ( XLV ), is an exchange-traded fund that tracks the performance of the U.S. health care sector. It provides investors with exposure to various segments of the health care industry, including pharmaceuticals, biotechnology, medical devices, and health services. The fund includes holdings from some of the largest and most established companies in the sector.

Being the most established in its category, XLV sees extensive use for both strategic and tactical positions. It follows a capital-weighted approach and exclusively selects from the S&P 500, resulting in a significant emphasis on mega-cap companies. The ETF is issued by State Street Global Advisors and has an expense ratio of just 0.10%, representing the annual costs when investing in the ETF. It holds assets worth $38.40 billion and tracks the S&P Health Care Select Sector Index. It belongs to the MSCI USA IMI Health Care Index segment and operates as an open-ended fund.

Holdings

The ETF currently has 67 holdings, while the top 10 holdings account for a total weight of 56.01%. As briefly mentioned before, the ETF follows a market capital-weighted approach, similar to the S&P 500 ( SPY ), meaning its assets are rebalanced based on changes in market capitalization. The ETF is capped at 10%, meaning a single stock should not account for more than 10% of the total ETF.

The ETF's largest holdings include many well-known companies such as healthcare giant Eli Lilly and Company ( LLY ), which is best known for producing insulin, particularly the brand Humalog, which is widely used in the treatment of diabetes. Healthcare and insurance provider UnitedHealth Group ( UNH ) also accounts for 10% of the total assets. Next follows pharmaceutical and consumer health company Johnson & Johnson ( JNJ ), being the ETFs third largest holding. Pharmaceutical large-caps Merck ( MRK ) and AbbVie ( ABBV ) both make up roughly 5.5% of the total assets.

Furthermore, the ETF includes many other well-known healthcare and pharmaceutical companies, such as Thermo Fisher Scientific ( TMO ), Pfizer ( PFE ) and Danaher ( DHR ). Overall, the ETF is well diversified and includes most well-known healthcare stocks.

Performance

As large cap tech stocks such as Microsoft ( MSFT ), Alphabet ( GOOGL ) and Meta Platforms ( META ) surged over the past year due to rising hopes for artificial intelligence ((AI)) growth, the S&P 500 outperformed XLV by a wide margin. Many healthcare stocks also face slowing demand from Covid-related treatments such as Pfizer, which saw its sales falling over 50% in the most recent quarter. As a result, the stock is down over 25% year-over-year. Nevertheless, other stocks such as Eli Lilly helped to compensate, surging over 80% since last year, as the company reported growing sales in the last quarter.

Despite this, Eli Lilly alone was insufficient to drive superior performance for the ETF. The ETF performed almost identical to similar healthcare ETFs such as Vanguard Health Care ETF ( VHT ) or iShares U.S. Healthcare ETF ( IYH ), which share many of the same names, yet have a slightly different weighting and rebalancing strategy. VHT also has a small expense ratio of just 0.10%, yet includes more holdings, counting 411 holdings in total. iShares U.S. Healthcare ETF ( IYH ) is more concentrated with only 119 holdings, yet has a much higher expense ratio at 0.40%.

Nevertheless, the ETF's performance is close to the S&P 500's over the last decade, and even outperformed in many years. Moreover, it tends to fare better in market downturns as seen during the Covid-crash or the end of last year. Overall, the ETF returned 198.5% over the past 10 years, compared to the S&P 500, which returned 205%.

Valuations

Compared to many Technology-focused ETFs such as IWF iShares Russell 1000 Growth ETF, XLV's holdings are trading at reasonable valuations. In this regard, many pharmaceutical large caps such as AbbVie, Merck, Pfizer are trading at only 10 times forward earnings, despite solid profit margins and healthy balance sheets. The only truly 'expensive' stock is Eli Lilly, trading at 48 times forward earnings. While the company is set to grow earnings quicker than the other holdings, at a Price to Sales ratio of 16 times, even future growth may seem to be priced in.

Overall, XLV trades at an average price-to-earnings ratio of 22.84 and at a price-to-book ratio of 4.67. It currently offers a distribution yield of 1.62%, representing the annual dividend of the ETF. In comparison, VHT and IYH trade at an average P/E ratio of 26.9x and 26x, respectively. This suggests that XLV offers favorable valuations, compared to alternative healthcare ETFs, which also include smaller and less profitable companies. Moreover, the ETF trades at a small discount to the S&P 500, which currently holds a P/E ratio of 24.7x.

Takeaways

For focused exposure to leading health care names, XLV is tough to beat. With an expense ratio of just 0.10%, it offers a solid opportunity to invest into the ever growing healthcare sector. XLV ETF comprises the foremost and most innovative stocks leading the way in the healthcare sector. These companies are well-positioned to capitalize on not only current trends but also long-term secular tailwinds shaping the industry's future.

Nevertheless, investing in XLV ETF presents various risks that should be taken into consideration. These risks include exposure to market fluctuations, as the ETF's performance is influenced by broader market conditions. It also has sector concentration risk, given its exclusive focus on healthcare, which makes it vulnerable to regulatory changes, healthcare policy shifts, and drug pricing pressures.

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