My healthcare equity allocation

I decided to write something about the 5% healthcare allocation in my portfolio. Generally, sector investing (with the possible exception of precious metal equity and REITs) is discouraged by many authors (including Bernstein, Swedroe, Ferri, Bogle etc). In my portfolio, I have made an exception to include a healthcare allocation.

The reasons for my healthcare allocation are as follows:

  1. A hedge against rising healthcare costs, especially during retirement. The cost of medical insurance has been increasing rapidly in the past few years. The primarily beneficiaries had been HMO companies like Wellpoint (WLP) and United Health (UNH).
  2. A hedge against my heavily tech-dependent employment and stock option grants. Healthcare is generally quite un-correlated to the tech industry. Note that to avoid unnecessary portfolio skewing due to the option grants, I have not included my company stock exposure in my listed target portfolio.
  3. I believe I have the conviction to follow through the spikes or crashes in the healthcare sector.

Out of the three reasons listed, I am particularly interested to hedge against the rising healthcare insurance and delivery costs.

I looked at two main classes of investment vehicles: mutual funds and ETFs. I did not want to include individual stocks.

Mutual funds

VGHCX : Vanguard’s Healthcare fund is a fine fund and is often held up as an example of a good actively-managed fund. It has a very low expense ratio of 0.25% and a turnover rate of 14%. Unfortunately, this fund is closed to new investors.

ICHCX : ICON’s Healthcare fund has suggested by some as a replacement fund for the closed VGHCX. This fund has an expense ratio of 1.22% and is a NTF fund at many brokers. The turnover rate is 48%.

PRHSX : T. Rowe Price’s healthcare fund has an expense ratio 0.91% and is said to be run by a former M.D. This fund is heavy on the biotech side and has a turnover rate of 56%.

SCHLX : DWS’s healthcare fund has an expense ratio of 1.39% and a turnover rate of 56%.

SWHFX : Schwab’s healthcare fund has an expense ratio of 0.89% and turnover rate of 42%.

FSHCX : Fidelity’s Healthcare delivery fund concentrates on healthcare delivery companies. This fund has an expense ratio of 0.95% and, is particularly attractive to me since it represents the best hedge against rising healthcare insurance. But, in my opinion this fund seems to have the high turnover rates that are typical of so many Fidelity funds (see other story here on the 234% turnover rate in the Fidelity International Real Estate fund). The turnover rate for this fund is 106%.

Other mutual funds I looked at included ALSIX and FSPHX.

ETFs

Most of the above mutual funds are diversified across healthcare industries but actively-managed funds could potentially have huge capital-gains distributions. Since I intend to hold the investments mostly in the taxable account, ETFs could be more suitable due to their better tax-efficiency.

I looked at ETFs that cover the four healthcare industries

Pharmaceuticals : XPH (ER 0.36%), PJP (ER 0.6%), IHE (ER 0.48%)
Biotechnology : PBE (ER 0.6%), XBI (ER 0.36%), IBB (ER 0.5%)
Healthcare service : IHF (ER 0.48%), PTJ (ER 0.6%)
Healthcare devices : IHI (ER 0.48%)

Given the downward trend in brokerage commissions and ETFs’ tax-efficiency, I decided to invest my healthcare allocation using ETFs. I selected the first three industries for investment since they are larger (in terms of market cap) and for the reason that tax-swap replacement ETFs are available if I ever need to tax-harvest.

The ETFs I selected are XPH, PBE and IHF. I have been investing into them with equal weighting.

3 Comments

  1. choozm

    Looks like you are tracking three indexes from different providers. Won’t it be better to choose one index provider that has all the four sub indexes? Hmm.. but looks like there is no index that covers all four sub-sectors. DJ index covers 1, 3 and 4. SPDR covers 1 and 2. SPDR are all large caps as it is a portion of S&P 500.

    I wonder why you choose PBE that has higher ER than XBI and IBB?

    Reply
  2. choozm

    Looks like you are tracking 3 indexes from 3 different providers. Won’t it be better to use one index provider to track all four sub sectors? Hmm… But DJ only track 1, 3, and 4. SPDR only tracks 1 and 2, and it is part of S&P 500.

    I wonder why you choose PBE that has higher ER than XIB and IBB?

    Reply
  3. indexfundfan (Post author)

    Reason for PBE is because XIB has very low trading volume while IBB contains only Biotech stocks trading on the Nasdaq, plus it is heavily weighted by one stock (AMGN at ~15%).

    Reply

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