NVCR - VHT: You Won't Get Defensive Healthcare Exposure Here

Summary

• Healthcare is considered a defensive sector and due to the brand name and cheap exposure, Vanguard's ETF prima-facie looks like a promising idea.
• However, outsized exposure to pharmaceuticals and biotechnology makes VHT a high beta healthcare ETF, undermining its defensive qualities.
• VHT's does not benefit from by having its largest sub-sector mix in pharmaceuticals, as these companies have to face the prospect of price cuts head-on.
• Key tailwinds include an aging population in the US and the growth of smart healthcare, but I believe it is insufficient to turn VHT into a buy.

Introduction

In a slowing economy, healthcare is often seen as a defensive play. The Vanguard Health Care ETF ( VHT ) was a default option I considered for my own portfolio due to its typically low fees . However, deeper analysis reveals that although there are long term growth drivers from an aging population and the emergence of smart devices used in real-time tracking of biometrics, immediate term revenue hits on the pharmaceuticals side undermines VHT's attractiveness.

Furthermore, a look inside the VHT ETF shows higher than expected beta exposure. This suggests that VHT may not be the right instrument for defensively playing healthcare.

VHT ETF Exposure Mix

Sub-Industry Mix

VHT has broad representation across healthcare sub-sectors. Typically, healthcare is considered to be a defensive sector. However, I believe the 47% exposure to pharmaceuticals and biotechnology makes VHT a little bit more volatile than traditional healthcare. This is because the betas of pharmaceuticals and biotechnology sub-sectors are 1.20 and 1.18 respectively, whilst the beta of traditional hospitals and healthcare facilities is 0.72.

Top 5 Holdings Mix

VHT's top 5 holdings include UnitedHealth Group ( UNH ), Johnson & Johnson ( JNJ ), Eli Lilly & Co. ( LLY ), Pfizer ( PFE ) and AbbVie ( ABBV ).

With an overall top 5 weight of 31.3%, VHT is rather diversified, which is a good sign as it reduces diversifiable risk in the portfolio. Managed healthcare, pharmaceuticals and biotechnology sub-sectors are seen in the top 5 exposures. My fundamental drivers' analysis accounts for key trends in each of these areas:

Key Trends

The key trends spanning managed multiple sub-segments of healthcare are:

1. Aging population in the US

2. Growth of smart healthcare

3. Pricing restrictions on prescription drugs

Aging Population in the US

According to the Federal Interagency Forum on Aging related Statistics in 2020, around 1 in 6 Americans were aged 65 and over, and this is projected to rise to 1 in 5 as soon as 2030. This not only represents a change in age composition, but a large increase in the number of older Americans, from 56 million in 2020 to 73 million in 2030.

This is confirmed via population pyramid analysis as well:

The growth in the number of older Americans is driven by both a larger population and longer life expectancy, which has been made possible by advancements in the medical field. The higher proportion of older Americans will result in increased demand for healthcare services, which gives a tailwind for the performance of VHT.

Growth of smart healthcare

One of the key technological themes is remote patient monitoring ((RPM)), which uses smart devices to monitor users' health in a dynamic way, and even treat or alleviate certain medical conditions such as cancer. One of my previous articles on NovoCure ( NVCR ) discusses this in more depth.

The chart above shows that RPM is a high growth niche within the biotechnology and medical devices sub-sector. By 2025, more than a quarter of Americans are expected to use some form of tool to enable smart, remote monitoring of their health.

Ultimately, the growth of this nascent opportunity presents many revenue tailwinds for the biotechnology, medical devices, health care equipment and life sciences parts of the VHT ETF.

Pricing Restriction on Prescription Goods

On August 16, US president Biden signed the Inflation Reduction Act. One of the objectives of the Act is to lower the cost of prescription drugs. Naturally, this poses a threat for the pharmaceutical firms, as a reduction in drug prices means erosion of revenues. The impact is estimated to be a $200 billion hit in foregone revenues by 2031.

This hit on pharmaceutical revenues may be a drag on the industry's historically high revenue growth, which on average was around 30% for top biopharmaceutical companies globally from 2014 to 2021.

Technical Analysis

If this is your first time reading a Hunting Alpha article using technical analysis, you may want to read this post , which explains how and why I read the charts the way I do, utilizing the principles of Flow, Location, and Trap.

Relative Read of VHT ETF vs S&P500

The relative chart of VHT/SPX500 shows price failing to break the consolidation area formed over the previous 8 years. I anticipate a move back towards the immediate monthly support zone, which suggests underperformance of VHT relative to the S&P 500 ( SPY ) ( SPX ).

Standalone Read of VHT

The standalone chart shows VHT oscillating between newer support and resistance areas formed in the last couple of years. I anticipate an upward move towards the monthly resistance at $265.

Summary

Overall, the VHT ETF benefits from favorable tailwinds of an aging population and adoption of new technologies such as remote patient monitoring, which opens up fresh growth avenues. However, this is partially offset by reduced pharmaceutical drug prices due to the Inflation Reduction Act. I believe this is a big blow to the VHT ETF as pharmaceuticals have a 28% weight in the overall ETF. Moreover, due to high pharmaceuticals and biotechnology weights, which are high-beta sub-sectors, VHT does not provide the typical defensive positioning associated with healthcare stocks.

From the technicals' perspective, although I believe VHT will make positive returns in the quarters going forward, I believe it is likely to underperform the S&P 500.

Hence, I am adopting a 'hold' stance on this ETF, waiting for more bullish triggers, especially on the pharmaceuticals' segment.

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