In times of uncertainty, health-care ETFs offer a defensive investment choice

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In times of uncertainty, health-care ETFs offer a defensive investment choice

“With the new technology and the new advances coming up, it’s nice to see there’s still a lot of growth potential in the sector,” said Nick Piquard, chief options strategist with Hamilton ETFs in Toronto. Piquard is lead portfolio manager of the Hamilton Healthcare Yield Maximizer ETF (TSX: LMAX).

The $120-million ETF, which launched in February, provides exposure to an equal-weight portfolio of primarily U.S.large-cap health-care companies. The ETF employs an active covered-call strategy and has a 0.65% management fee.

The ETF holds the top 20 health-care stocks in North America, Piquard said. These include health insurance and services firm UnitedHealth Group Inc., pharmaceutical firm Eli Lilly & Co., pharmaceutical and biotechnology firm Pfizer Inc., and life science and clinical research firm Thermo Fisher Scientific Inc.

“You have a lot of pharmaceutical companies in the sector, which are more defensive [and] have good dividend yields, but then you also have a lot of growth potential with biotechnology stocks and medical device stocks,” Piquard said.

And given the volatility in the portfolio, “we can get a good amount of premium on the call options that we sell,” he explained.

The Harvest Healthcare Leaders Income ETF (TSX: HHL) is another option. A Canadian-dollar-hedged version of the fund launched in 2014, followed by a U.S.-dollar version in 2017 (TSX: HHL.U) and an unhedged Canadian-dollar version in 2020 (TSX: HHL.B).

HHL has $1.5 billion in assets under management and a management expense ratio (MER) of 0.99%. Like LMAX, HHL employs an active covered-call strategy to generate an enhanced monthly distribution yield.

The ETF holds 20 large-cap global health-care companies, which are equally weighted. The holdings include Johnson & Johnson; animal-health firm Zoetis Inc.; medical tools, software and equipment firm Agilent Technologies Inc.; and biopharmaceutical firm Amgen Inc.

To craft the portfolio, Harvest ETFs scanned the global market for North America-listed health-care companies with a minimum of $10 billion in market capitalization, said Paul MacDonald, chief investment officer and portfolio manager with Oakville, Ont.based Harvest ETFs.

This resulted in a list of 85 companies, of which the firm picked 20. “I think we really capture the essence of diversified health care,” MacDonald said.

A Harvest spokesperson added that holding 20 stocks in the ETF “allows us to know the companies well and, importantly, from an options trading perspective, allows us to be more flexible.”

Toronto-based Brompton Funds Ltd.initially launched its closed-end Global Healthcare Income & Growth Fund in 2015, but converted it to an ETF in 2018 (TSX: HIG).

A U.S.-dollar version of the Global Healthcare Income & Growth ETF (TSX: HIG.U) launched in 2019.

Brompton’s $54-million ETF provides exposure to an actively managed portfolio of large-cap global health-care companies. Like LMAX and HHL, HIG’s portfolio is complemented by a proprietary covered-call options program. HIG’s MER is 0.96%.

“Canadian investors tend to like funds with enhanced distributions, so when we listed HIG in 2015, we decided to take the same approach as we had for several other of our funds and make it covered-call focused,” said Chris Cullen, senior vice-president and head of ETFs with Brompton Funds in Toronto.

The Brompton ETF’s holdings include Novo Nordisk A/S, biotechnology firm Intuitive Surgical Inc.and medical technologies firm Stryker Corp.

Overlapping holdings among the Hamilton, Harvest and Brompton ETFs include Eli Lilly & Co., Merck & Co. Inc.and Johnson & Johnson.

Brompton tends to overweight non-drug companies in its ETF because they aren’t exposed to the same risks as pharmaceutical and biotechnology companies, such as cycle times in drug development and patent expirations, said Mike Clare, vice-president and senior portfolio manager with Brompton Funds.

“We have a fairly diversified health-care portfolio, but we would roughly break the health-care space into two large groups,” Clare said. “You’ve got drug stocks, as well as biotech, which make up about 55%–60% of the health-care market. And then you’ve got everything else, [such as] medical device manufacturers, health-care providers, service companies, suppliers, life sciences, tools — things like that.”

Other health-care ETFs in Canada include the TD Global Healthcare Leaders Index ETF (TSX: TDOC), iShares Global Healthcare ETF (TSX: XHC) and BMO Equal Weight US Health Care Index ETF (TSX: ZHU).

Who are these funds for?

The health-care sector tends to have lower volatility than other sectors, such as technology, so investing in health-care funds “may be a key way for investors to get exposure to the market with a little bit less volatility, a little bit less risk,” Clare said.

Health-care ETFs also allow Canadian investors, whose portfolios tend to be underweighted in the health-care sector, to diversify and tackle their home country bias, Clare said. The sector accounts for 0.3% of the Toronto Stock Exchange’s market capitalization, he said, compared with about 12% in the U.S.and global markets.

Piquard cautioned that health care is “still a volatile sector,” so those looking to invest in health-care ETFs must have some risk tolerance.

However, he said it is precisely this volatility that makes a covered-call strategy suitable for health-care funds because “the dividend yield is not terribly high” among health-care companies.

“Where there’s more volatility, it allows you to get higher call option prices, which allows us to get a higher yield,” Piquard explained.

The outlook for health-care ETFs

The world’s largest asset manager, BlackRock Inc., is projecting that despite health care’s relative underperformance in 2023, its 12-month forward earnings are expected to outpace all other sectors in 2024.

Piquard, MacDonald and Clare also shared a positive outlook. They pointed out that with one in six people expected to be older than 60 by 2030, and the middle-class demographic growing in developing countries, health-care expenditures are likely to rise.

Technological advancements in health care, such as with robotic-assisted surgery, artificial intelligence and genomic sequencing, along with the rise in popularity of GLP-1 drugs for diabetes and weight loss, are also notable developments, they said.

“Those powerful drivers are just not going away. And in the shorter term, I see some tactical opportunity from some of the rotation that we see within the broader markets,” MacDonald said.

Moreover, the Covid-19 pandemic exposed cracks in health systems around the world and highlighted the need for governments to invest in health care, Piquard said.

Clare touted the health-care sector’s defensive characteristics. “Obviously, if we enter a downturn or a recession — which is not our base-case view — but to the extent that happens, health-care sector revenues and earnings typically hold up very well,” he said.

“You can stop buying furniture for your house, but you’re not going to stop buying the health care you need to live a healthy life, right?”

This article appears in the September issue of Investment Executive. Subscribe to the print edition, read the digital edition or read the articles online.

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