PSCH - PSCH: A Small-Cap Healthcare ETF Having Strong Growth Potential With Proportionate Risk

2023-08-23 20:55:27 ET

Summary

• Invesco S&P SmallCap Health Care ETF is a well-diversified healthcare fund that invests in US-based small-cap companies in the healthcare sector.
• The fund has a history of strong growth and is projected to continue growing due to innovation in the sector.
• While the fund has had a poor total return in recent years, it has generated a high average total return during the 2016-2021 high-growth period.

~ by Snehasish Chaudhuri, MBA (Finance)

Invesco S&P SmallCap Health Care ETF ( PSCH ) is an exchange-traded fund that invests in US-based growth and value stocks of small-cap companies in the healthcare sector. The sector experienced strong historical growth and is projected to grow more in the future. The sector is full of innovation in the long run and thus catches the interest of long-term investors. Although PSCH invests in small-caps, its asset under management is sufficient at $254.33 million. The fund was formed on April 7, 2010, and paid an irregular quarterly dividend for a few years before discontinuing it in 2018. Although the total return has been very poor this year, during the high-growth period between 2016-2021, the fund generated an annual average total return of 17.1 percent .

Well-Diversified Healthcare Fund Investing in High-Growth, Innovative Companies

Invesco S&P SmallCap Health Care ETF uses the S&P SmallCap 600 Capped Health Care Index as its benchmark. S&P Dow Jones Indices, LLC compiles, maintains and calculates the index, which is designed to measure the performance of stocks of small-cap U.S.-based companies in the healthcare sector. Innovation drives growth, and small-cap healthcare firms are in a perfect position to achieve this innovation-led growth. As growth makes stocks costlier, an investor looking for low-value stocks might find these small-cap healthcare stocks attractive due to their low volume and familiarity.

Invesco S&P SmallCap Health Care ETF was launched and is managed by Invesco Capital Management LLC. PSCH is a highly diversified healthcare fund that includes double-digit allocations to biopharmaceuticals, diagnostics & research, health information services, medical care facilities, and healthcare equipment & medical devices. PSCH has been able to record steady revenue and earnings growth . Its year-on-year revenue growth stood at 7.15 percent, while earnings grew by 16 percent. PSCH has a beta of 0.9 implying that it gives exposure to high-growth, innovative companies that are as volatile, if not more volatile, than the market. The overall risk of PSCH is not exceptionally high.

Barring 2022 & 2023, PSCH's Annual Average Total Return Was Exceptionally High

Small-cap stocks generally are traded less than the large-cap and mid-cap stocks. At the same time, there are higher chances of these stocks not generating significant returns over an extended period of time. During the past 5 years, the annual average total return was negative 2.3 percent. However, this happened primarily due to the returns of the past two years, which has been the case with all funds and broader markets. During the high growth period of 2016 to 2021, its return was very high. The fund also has an expense ratio of 0.29 percent, which enables investors to benefit from its diversified portfolio. There is some concern about the future price performance of PSCH, as small-cap funds may not witness any growth if there is a global recession.

Major Holdings in Healthcare Equipment and Facilities Generating Strong Returns

Investing in small-cap stocks has the basic advantage that the fund can have a significant stake in a company by investing relatively small amounts. Only 18 stocks account for the top 50 percent of PSCH's investment. These stocks primarily belong to three groups - healthcare equipment, healthcare facilities & services, and biopharmaceuticals. Healthcare equipment has been the best-performing segment since the onset of covid-19 pandemic in early 2020, and even the small-caps are not an exception. Stocks such as Merit Medical Systems Inc ( MMSI ), Integer Holdings Corp ( ITGR ), Glaukos Corp ( GKOS ), and CONMED Corp ( CNMD ), although small-caps, are relatively familiar firms. All these stocks recorded high double-digit price growth during the past one year.

As the demand for healthcare increases, there is an increasing need for healthcare facilities and services such as clinical services, diagnostics, etc. Similar to healthcare equipment, these companies are also non-cyclical in nature. Healthcare facilities & services companies like Ensign Group Inc ( ENSG ), Select Medical Holdings Corp ( SEM ), CorVel Corp ( CRVL ), and NeoGenomics Inc ( NEO ) also posted positive price growth over the past one year. Despite that, its price dropped by almost 16.5 percent during that period.

Major Pharmaceutical Investments Led to Poor Price Growth on a Consistent Basis

It was the biopharmaceutical stocks that led to poor price growth of Invesco S&P SmallCap Health Care ETF. Since the COVID-19 pandemic, these stocks have been highly volatile. Although it was expected that biopharmaceutical stocks would witness steady upward movement, due to a rise in healthcare costs, the case has not been so. Pacira BioSciences Inc ( PCRX ), Prestige Consumer Healthcare Inc ( PBH ), Tandem Diabetes Care Inc ( TNDM ), Cytokinetics Inc ( CYTK ), and Fortrea Holdings Inc ( FTRE ) made huge losses in terms of price. They failed to generate positive price growth both in 2023, as well as during the past five years. Small-cap pharmaceutical firms also undergo the risk of losing out to the large-caps, in terms of growth and stability. Despite being alpha-generating stocks, these stocks suffer due to a high level of uncertainty.

Investment Thesis

The healthcare sector experienced strong historical growth and is projected to grow more in the future, primarily due to its ability to innovate. Invesco S&P SmallCap Health Care ETF is one such highly diversified healthcare fund that includes double-digit allocations to pharmaceuticals, medical care facilities, diagnostics & research, healthcare services, and healthcare equipment & medical devices. The fund has been able to record steady revenue and earnings growth. Although the total return has been very poor during 2022 and 2023, the high-growth period between 2016-2021 generated an annual average total return of 17.1 percent. The fund also has an expense ratio of 0.29 percent, which enables investors to benefit from its diversified portfolio.

However, on the flip side, the fund does not offer any payout. PSCH's major holdings in the biotechnology and pharmaceutical segment have been generating price losses on a consistent basis. Despite being alpha-generating stocks, these small-cap stocks suffer due to a high level of uncertainty. Its portfolio includes only 75 stocks, and half of its assets are invested only in 18 stocks. Betting on such a narrow group of small-cap stocks may be detrimental in the future. For reference, its benchmark index tracks 600 stocks. However, this fund has a beta of 1.08, suggesting its low level of volatility. Overall, I feel this fund is not very risky, and once the market goes back to the pre-pandemic level, this fund will again start generating strong price growth. I'd assign a hold rating for PSCH's strong growth potential, but lack of payout.

For further details see: