While not as exciting or eye-catching as some other global topics of the day, exchange traded funds that follow pharmaceutical companies are holding up and may provide an investment portfolio with a healthy defensive option, with some dividends to boot.
The industry includes developers and manufacturers of pharmaceutical products, including companies in the forefront of developing, testing and marketing new drugs worldwide.
Pharmaceuticals are a sub-sector of the broader healthcare sector. Specifically, ETFs that cover the pharmaceutical sector do not include the services and medical-devices companies found in a broad healthcare fund. Instead, drug, pharma and biotech companies largely dominate this particular area of the market. These companies are vertically integrated and tend to carry out drug discovery, testing and commercialization of products.
Pharmaceutical ETFs are highly correlated to the overall healthcare sector, so investors should be wary of overweighting a portfolio with healthcare investment holdings. Given the healthcare sector's lower correlation to the general economic environment, the pharmaceutical sub-sector can be a good defensive addition for an investment portfolio.
The healthcare sector has generally been viewed as a defensive, or noncyclical, investment that could also provide growth appreciation prospects from the aging baby-boomer generation. The overall sector has experienced a relatively stable demand throughout various economic cycles since consumers tend to demand basic healthcare services and products in any economic environment.
Furthermore, the aging U.S. population helps boost the fundamental appeal of the overall sector. Looking ahead, the aging baby-boomer generation will require greater care and increased medical treatment.
Companies within the pharmaceutical and biotechnology sectors are highly active in acquiring and merging smaller startups. Big Pharma companies have been trying to acquire small biotech firms that hold promising new products in an attempt to beef up their own product line as patents on large blockbuster drugs begin to expire. So consolidation could be a theme here.
With the healthcare reform passed and signed, potential pharmaceutical ETF investors will need to assess how the newly enacted law will impact the industry. For instance, the greater burden placed onto pharmaceuticals may force companies to incur greater costs as they adapt to the changes in the industry. Consequently, revenue may be depressed in this short-term, transitional period.
However, the healthcare reform forces greater healthcare coverage, which increases the number of insured patients and should help the industry over the long-run - more consumers buying a service or good will help increase revenue generated for the manufacturer or provider. For instance, under the Affordable Care Act, uninsured individuals between the ages of 26 to 64 will be able to obtain coverage through their employer or through subsidized individual plans and senior citizens who were previously unable to get prescriptions will also be covered. Conservative estimates put the U.S. drug market at around $440 billion in 2015, or 12.5% of total healthcare spending, and almost $700 billion in 2020, or 14% of total healthcare spending.
Pharmaceutical observers are also keeping a close eye on the U.S. Supercommittee, especially on whether or not Congress will cut federal payments on prescription drugs as the government tries to reduce the deficit by $1.2 trillion. Needless to say, any tampering to federal payments on prescriptions medication will hurt the pharmaceutical industry and might even cause massive job cuts within the industry.
The pharmaceutical industry holds some prominent names, but the sector is mostly dominated by a large swath of smaller individual companies. Pharmaceutical ETFs offer investors a broad investment exposure to the sub-sector and helps mitigate the risks involved with picking individual stocks - smaller stock offerings have been known to experience wild swings as the drug providers try to pass regulatory hurdles on their road to FDA approval. ETF products hold a basket of companies, which help diminish company-specific risks.
Pharmaceutical HOLDRS (PPH) is the largest pharmaceutical-themed fund, with $478 million in assets. The HOLDRS fund, though, is scheduled to delist and undergo liquidation later in 2011, but Van Eck will provide investors the opportunity to swap their shares for an ETF with the same ticker symbol.
The iShares Dow Jones U.S. Pharmaceuticals Index Fund (IHE) has $248 million in assets. The fund has an expense ratio of 0.47%. IHE follows a market-cap weighted methodology and the fund's top holdings account for the majority of the fund's weighting.
SPDR S&P Pharmaceuticals ETF (XPH) has $244 million in assets. The fund has an expense ratio of 0.35%. IHE follows an equal-weighting methodology, which provides a heavier weighting to mid- and small-cap companies.
Powershares Dynamic Pharmaceuticals Portfolio Fund (PJP) has $167 million in assets. The fund has an expense ratio of 0.63%. PJP tracks the Dynamic Pharmaceuticals Intellidex, which is a fundamentally-based Index model that evaluates companies based on a variety of criteria, including fundamental growth, stock valuation, investment timelines and risk.