2023-08-21 06:18:21 ET
Summary
- iShares U.S. Pharmaceuticals ETF invests almost 80 percent of its assets in its top 10 holdings, and 48.5 percent in just two companies: JNJ and LLY.
- IHE didn’t generate strong or decent yield, but provided price growth over the long run and has been much more effective during bearish market conditions.
- Stocks in IHE's portfolio possess popular & life-saving drugs and thus are recession resilient as the medication will be needed regardless of any recession.
- The worldwide aging population presents enormous opportunities for the pharma stocks included in IHE's portfolio, as the need for drugs also grows significantly.
IHE's Portfolio is Highly Concentrated on A Few Large-Cap Pharmaceutical Stocks
iShares U.S. Pharmaceuticals ETF ( IHE ) is an exchange traded fund that invests in large-cap stocks of companies operating across health care, pharmaceuticals, biotechnology and life sciences sectors. The fund invests almost 80 percent of its assets in its top 10 holdings, and around 48.5 percent in just two companies: Johnson & Johnson ( JNJ ) and Eli Lilly and Company ( LLY ). This makes this fund risky and highly dependent on the performance of these two companies. The fund doesn't generate strong or decent yield, but is aimed to provide NAV growth at times. IHE is currently trading at a marginal premium of 0.03 percent. This ETF obviously will suit those investors who are seeking to make fast cash out of a pharma bull run. But again, investing in this highly regulated sector poses multiple concerns about its long-term returns.
Being an iShares fund, this ETF is managed by BlackRock Fund Advisors. The fund uses representative sampling techniques to create its portfolio by following the Dow Jones U.S. Select Pharmaceuticals Index as its benchmark. This index measures the performance of a group of large-cap pharmaceutical companies that cover one or more of three core functions: product research, drug development, and manufacturing of prescription or over-the-counter drugs or vaccines. All these companies in general, undergo a high degree of regulation. These companies also take time to generate revenues from any of their new drugs, as the drug development process takes between 7 to 9 years.
Favorable Factors Will Drive the Future Growth of Healthcare Sector Globally
iShares U.S. Pharmaceuticals ETF was formed by BlackRock, Inc. in 2006. It has been paying quarterly dividends since then. However, IHE generates a low Dividend Yield . Stocks in its portfolio derive the maximum benefit out of rising global pharmaceutical demand. These stocks should benefit from a worldwide aging population. The United Nations in its World Population Prospects predicted that by 2050, globally one in six people will be over the age of 65, up from one in eleven in 2019. By 2050, a quarter of people living in Europe and Northern America will belong to that age group. This presents enormous opportunities for the pharmaceutical stocks included in IHE's portfolio to grow their businesses as the need for drugs or vaccines should also grow significantly.
IHE Has the Potential to Capitalize on Growth Opportunities Available in Healthcare
These companies possess rich drug development pipelines, which will help them to remain competitive by introducing more drug patents in the future, even after expiration of their existing drug patents. In addition, stocks in IHE's portfolio generally possess popular & life-saving drugs and thus are recession resilient as people will need medication regardless of an economic recession. Given the favorable long-term growth outlook, I believe the fund is a good choice for investors with a long-term investment outlook. However, competition provided by the companies not included in IHE's portfolio may hurt the fund's returns.
Stocks in IHE's portfolio also face regulatory risks as governments can impose restrictions on drug margins. In addition, governments can pass regulations that reduce the number of years of exclusivity. This will impact the margin of stocks in IHE's portfolio and likely result in margin compression. IHE's fund price will likely fall if such a situation happens. Despite all these, I think this ETF is a good long-term option for investors. The fund should continue to benefit from an aging demographic trend and continual demand for pharmaceuticals in the next decade. For investors having a long-term investment objective, IHE is a good investment choice for capital appreciation.
Despite High Concentration on Few Stocks IHE's Portfolio Seems to Be Less Risky
IHE's portfolio has a much lower beta (5 year monthly beta) of 0.56, which makes it less volatile than the market. So, when the market is bearish, this fund provides a relatively better return than when the market is bullish. Over the past three years, while S&P 500 generated a price growth of 28.64 percent, IHE's price growth was 14.36 percent. But, during 2023, when the markets are moving in the upward direction, IHE's price growth of 1.7 percent was much lower than that of S&P 500, which stood at 13.3 percent.
Now, the S&P is expected to grow multi-fold over the next few years. This may be bad news for long-term investors of IHE, as it is expected to underperform due to low beta.
However, on the valuation front, iShares U.S. Pharmaceuticals ETF does not seem to be an overvalued fund. Its price multiples are relatively lower than that of the index. IHE's price to earnings (P/E) ratio and price to book value ratio stands at 14.25 and 3.31 respectively. Index has a P/E of 18.53 and P/B of 4. IHE's price to cash flow (P/CF) of 12.16 is also lower than the index's P/CF of 14.54. Thus, this fund seems to be an adequately valued ETF, despite trading almost at par. This brings down the risk involved in investing in IHE.
Investment Thesis
As governments and individuals continue to spend more of their budgets on healthcare, the demand for pharmaceutical products is likely to increase. iShares U.S. Pharmaceuticals ETF has the potential to capitalize on the pharmaceutical industry's growth potential in both developed and emerging economies. An increased aging population will result in an increase in the number of patients with chronic diseases, and increase in the adoption of personalized medicine. Pharmaceutical companies are constantly researching and developing new drugs in order to meet this demand, and approving these drugs can lead to significant growth in financial & market price performance of the companies that IHE invests in. Pharmaceutical stocks also have been a popular investment option over the years and the large-cap pharma stocks will anyhow generate healthy returns over the long-run. Considering all these, IHE seems to be an adequately valued ETF, despite having a marginal premium.
For further details see:
IHE: A Highly Concentrated Portfolio Is Able To Generate Growth Over The Long Run