Why You Should Invest in Health Care Stocks Now

This sector tends to do well in both bull and bear markets. Here’s my favorite fund.

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As the stock market begins to anticipate a Hillary Clinton victory on November 8, health care stocks have been sliding. Since the beginning of August, when Clinton started to boost her lead over Donald Trump in the polls after the two parties’ conventions, health care stocks in Standard & Poor’s 500-stock index have lost 7.6% while the S&P 500 itself dipped just 0.9%.

The fear: that a Clinton administration would take steps to stem the rising prices of prescription medicines. The reality: Unless the Democrats win the White House and both houses of Congress, which looks unlikely, don’t expect any big changes in drug-pricing regulation.

What’s more, even if Washington did take measures to force down drug prices, the tailwinds propelling health care companies forward are remarkably strong. That’s why health care has long been my favorite industry.

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Start with the baby boomers. The huge cohort born in the U.S. between 1946 and 1964 is rapidly aging and consuming increasing amounts of health care products and services. People over age 75 use three to four times as much health care as younger folks.

Then consider the impact of emerging markets. As economies such as China and India continue growing at a fast clip, they’re creating a vast new global middle class. And one of the first things new entrants into the middle class want is more and better health care.

Innovation is bringing new treatments and cures for hitherto incurable diseases. Jean Hynes, manager of Vanguard Health Care (VGHCX (opens in new tab)), says an astonishing one-fifth of all the research and development being done by businesses is being conducted by the health care industry. Biotechnology is entering a “golden age” and producing most of the breakthroughs, says Hynes.

Over the long term, health care stocks have delivered, well, healthy gains to investors. Over the past 10 years, the S&P Health Care index returned an annualized 9.6%--an average of 2.7 percentage points better per year than the S&P 500. (All returns are through October 21.)

Yet health care stocks, as a whole, are currently cheaper than the overall market, thanks to the Hillary effect. The S&P Health Care index trades at about 15 times analysts’ consensus earnings estimates for the coming 12 months. The S&P 500 trades at 17 times estimated earnings.

What really wins me over to health care stocks is that they tend to perform well in both bull and bear markets. Health care has long been considered a defensive sector, relatively immune to the ebbs and flows of the economy’s cycles. Indeed, in the 2007-09 bear market, when the S&P 500 plunged 55.3%, the S&P Health Care index lost only 38.0%. Yet health care is also enjoying robust growth—for decades it has expanded at a faster pace than the overall U.S. economy.

Vanguard Health Care is my favorite way to tap this sector. One reason is the experience of its manager. Hynes, who is with Wellington Management, has worked on the fund since 1993, became comanager in 2008 and has been its sole manager since the start of 2013. Hynes, 47, joined Wellington after graduating from Wellesley College. She’s backed by six analysts and four research associates, who include medical doctors and PhDs.

The fund’s Investor share class, which requires a $3,000 minimum investment, charges a mere 0.36% per year in fees. If you can swing the $50,000 minimum or you use a discount broker with a lower minimum, then you’ll save a little with the fund’s Admiral share class (VGHAX (opens in new tab)), which charges 0.31% annually.

The Investor share class has returned an annualized 10.4% over the past 10 years—an average of 0.8 percentage point per year more than the S&P Health Care index and 3.5 points per year more than the S&P 500. When you’re paying so little for such a first-class management team, I see little reason to look elsewhere.

Hynes believes we’re entering a period that will be marked by the emergence of big winners and big losers in drugs and biotech. Investors will “differentiate between the real innovators and the companies with older drugs that are losing patent protection,” she says. Hynes says that 85% of pills taken orally today are generics, and that percentage will only increase. The use of “biosimilars”—generic versions of drugs produced in biotech labs—will also continue to grow, she predicts.

That has led her to make bigger bets on individual stocks than she had previously. The fund, which holds $48 billion in assets, has about 6% apiece of its assets in UnitedHealth Group (UNH (opens in new tab)), Allergan (AGN (opens in new tab)) and Bristol-Myers Squibb (BMY (opens in new tab)), and 5% in both Merck (MRK (opens in new tab)), and AstraZeneca (AZN (opens in new tab)).

Overall, the fund has more than 55% of its assets in what Hynes calls biopharma. She thinks it’s meaningless to distinguish between traditional pharmaceutical companies and biotech firms because they’re all involved in biotech research. Another 25% of the fund is in health care services, such as insurance, and the remainder, except for 3% in cash, is in medical devices.

I asked Hynes where she sees the next big breakthroughs in medicine. “The most exciting,” she says is “progress in unraveling cancer. We’re seeing a tremendous amount of real breakthroughs.” Unfortunately, Hynes declined to discuss individual stocks.

She’s also surprisingly optimistic about new treatments for Alzheimer’s disease, which has so far defeated all efforts to cure it. Finally, she sees progress in treating some 50 rare diseases where the understanding of genetics has brought cures closer.

Steve Goldberg (opens in new tab) is an investment adviser in the Washington, D.C., area.

Steven Goldberg
Contributing Columnist, Kiplinger.com
Steve has been writing for Kiplinger's for more than 25 years. As an associate editor and then senior associate editor, he covered mutual funds for Kiplinger's Personal Finance magazine from 1994-2006. He also authored a book, But Which Mutual Funds? In 2006 he joined with Jerry Tweddell, one of his best sources on investing, to form Tweddell Goldberg Investment Management to manage money for individual investors. Steve continues to write a regular column for Kiplinger.com and enjoys hearing investing questions from readers. You can contact Steve at 301.650.6567 or sgoldberg@kiplinger.com.