The cutting-edge biotechnology used to create COVID-19 vaccines put a spotlight on innovative healthcare companies. But these kinds of early-stage firms come with a lot of risk for investors.
Outcomes tend to be "binary – either very good or very bad," says Matthew Raynor, a managing director of the U.S. strategic client group for Principal Global Investors.
Principal Healthcare Innovators Index ETF (BTEC) is an index fund that invests in a diversified group of roughly 300 small and midsize healthcare companies focused on innovation.
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The portfolio includes biotech firms, medical device makers and medical services businesses, among others. Size is a parameter for inclusion in the fund; holdings have an average market value of $4.8 billion. Stocks that have "graduated" from the fund as they've grown too large include COVID vaccine developer Moderna (MRNA), removed in April.
Profitability – or lack of it – is another requirement. Only those companies with inconsistent or negative earnings patterns are eligible for the portfolio. That may seem "counterintuitive" for a stock fund, says Raynor, but it enables the fund to zero in on companies that are "leading the charge toward innovative solutions rather than spending money on corporate overhead, marketing and distribution."
That makes BTEC risky. But so far, it has been worth it. Over the past three years, the fund was 44% more volatile than the typical health care fund, but its three-year annualized return, 19.3%, beat 83% of the competition.
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