IYH - IYH: Good Way To Gain Exposure To The Healthcare Sector

2023-12-28 02:46:47 ET

Summary

• iShares U.S. Healthcare ETF provides exposure to the healthcare sector, holding 120 healthcare-related stocks.
• Healthcare stocks have had varying performances in recent years, with winners and losers in the sector.
• The increasing prevalence of chronic diseases and longer lifespans present opportunities for drug companies but also risks such as increased scrutiny and regulation.
• If you are in an index fund like SPY, you likely already have sufficient exposure to healthcare, but if not, you might want to add some.

iShares U.S. Healthcare ETF ( IYH ) is a sector-specific ETF for those investors who want to gain exposure to healthcare sector. The fund holds close to 120 healthcare-related stocks, most of which are pharmaceutical companies.

The last couple years have been very interesting for healthcare stocks with lots of ups and downs and wild roller coaster rides just to be up 5% in 2 years. Ironically, looking at the sector as a whole doesn't tell us the whole picture though because this sector had a lot of winners and losers during this time. One could call the story of healthcare stocks in the last couple years as "a tale of two cities" where you would get a completely different story depending on which healthcare stock you looked at.

The fund is somewhat unique in that it holds drug companies, insurance companies, medical tool companies, and some healthcare service companies even though the majority of its weight comes from drug companies. For example, the fund's top holding is UnitedHealth Group ( UNH ) which is a health insurance company but the remaining companies in its top 10 are mostly drug companies. We also have Danaher ( DHR ) and Thermo Fisher ( TMO ) and these companies produce medical goods such as diagnostic and analytical tools and a variety of devices used in medicine. So this probably sets this ETF apart from others that are mostly focused on drug companies alone. We can say that the fund is somewhat top-heavy as its 10 holdings account for 53% of its total weight and it's mostly weighted by market cap.

For example, when we look at some of this fund's top holdings, we see a wide range of performances. At the top, we see Eli Lilly ( LLY ) with its stunning 55% performance year-over-year. At the bottom, we see Pfizer ( PFE ) with its equally stunning underperformance of -45%. Other healthcare stocks had a variety of performances ranging from being up almost 10% to being down almost -30% so not all healthcare stocks were created equal this year.

It is often said that healthcare is a "recession-proof" sector because people have to seek healthcare and use medicine regardless of whether the economy is booming or is in a deep recession. It's one of the last expenses people will cut and much of it should be covered by insurance anyway. Just because this sector is not cyclical in nature doesn't mean healthcare companies won't have varying performances from year to year depending on what their drug pipeline looks like though.

When it comes to healthcare, a few trends are happening at once. First, people are living longer and longer, which means they will need to use medicine for longer and longer periods of time. Second, people are getting sick sooner and younger than ever before. We are now seeing diseases like diabetes, hypertension, and chronic heart disease in younger people when it was inconceivable just a couple decades ago. Third, a lot of the diseases people get today are based on lifestyle and are chronic in nature. Except for rare cases, once you are diagnosed with a chronic disease it will stay with you for the rest of your life and it will have to be managed through both lifestyle changes and medicine. Unfortunately, many people are not good at sticking with the necessary lifestyle changes so they develop more and more dependence on medicine.

So if people are living longer, getting sicker sooner, and getting more chronic diseases, that means drug companies will have a pretty large and ever-growing "captive audience" in the future (unfortunately for people, fortunately for drug companies). In the old days, one would get a chronic disease at 60 and pass away at age 70 which would mean that their disease would have to be managed for about 10 years. Now people get chronic diseases at 40 and live until 80 so their disease has to be managed for 40 years.

While this is a big opportunity, this could also turn into a risk for drug companies. Governments around the world who are paying for these drugs may start scrutinizing drugs for effectiveness and safety. We might also start seeing more regulations and more lawsuits which can easily eat into this sector's profits. As the number of people with chronic diseases increases, the governments and insurance companies around the world might want to negotiate better deals with drug companies in order to keep their costs in control. One thing we are certainly not seeing enough from most countries around the world is a way to fight these conditions before they happen. This would take a huge shift in people's diets, lifestyles, the way they move, the way they are transported, and even the way they work and not many countries are ready to make such a huge shift.

Our lifestyles are becoming increasingly sedentary and this is now not limited to America either. This is becoming a global epidemic. For example, take China which is the world's second-biggest economy. Until 30 years ago diabetes was almost unheard of in China. It was a very rare disease with a prevalence of 1% or less. By 2030, close to 10% of China is expected to be diagnosed with diabetes and it is expected to cost $460 the China billion to treat (more like manage since diabetes is not exactly treatable).

I would expect these trends to result in growth for the healthcare industry as a whole. We will see higher usage of medicine by more people for more years and we will likely see this usage not being limited to drugs either. We will likely see more focus on health monitoring and measuring. Companies like Apple ( AAPL ) are already working on new ways of measuring health such as blood pressure and glucose levels through their devices and this trend could help not only drug companies but also companies like Danaher and Thermo Fisher that produce analytical solutions. As drugs become more efficient and we become better at monitoring them, healthcare companies with better tools and better patents will win out while others may lose out but you will be fine if you are holding an ETF like this because you are not picking winners. Also, I see more usage of AI in the future in drug development and personalized medicine which can increase profits for the healthcare industry as a whole if this opportunity is taken by them.

One thing for certain. Investing in healthcare stocks usually results in nice dividend growth. In the last 20 years, IYH's dividend distributions grew by an average annual compounded rate of 15%. In the last 10 years, the fund's dividends grew by an annual average of 10%. Healthcare companies that are established and profitable are great at paying and raising dividends year after year. Still, the average yield is going to be below 2% so you won't really want to be investing in this for income unless you specifically go after those companies with high yields such as Pfizer but I wouldn't recommend yield chasing.

If you are already invested in an index fund like SPY ( SPY ), you probably don't need additional exposure to healthcare because the index includes many healthcare companies. As a matter of fact, healthcare is the second biggest sector within S&P 500 after technology and it claims close to 13% of the total weight. If you are invested in the overall index, you are probably well covered. If you are not, this is a good ETF to give you some exposure to the sector.

From a valuation perspective, just as different healthcare companies have different performances, they also have different valuations. Interestingly enough some of the top performers like Eli Lilly also happen to be the most expensive ones whereas bottom performers like Pfizer also happen to be the cheapest ones which tells me that as much as healthcare is concerned, future growth opportunities matter more than valuations. Having said that, the average P/E of IYH is currently 23 which is about the same as S&P 500's P/E average. As a whole, the fund is neither cheaper nor more expensive than the overall market.

Moving forward healthcare profits are expected to rise from 6-10% per year for the foreseeable future so if you are a long-term investor this is still a sector you want to be exposed to when all things are considered.

This is not an ETF that can make you rich quickly so don't expect huge returns but you will likely get close to 10% in total returns between dividends and price increases. This ETF is more for conservative investors who'd like to see their portfolio grow slowly but steadily. If you are looking for quick gains, you might have to do some stock picking within the sector but there is a realistic chance that your stock picks might not turn out to be great so it's always safer to be in an ETF than trying to pick winners and losers within a sector.

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