Healthcare reform has been in the news a lot lately, with constant finger-pointing, debate, and competing versions of comprehensive bills. Although the passage of comprehensive reform appears to be less certain that it was only weeks ago, it remains likely that major changes are coming before the end of the year. While many specifics are still up in the air, it is becoming clear that the outcome of this issue could make a major impact from Main Street to Wall Street. So what does all the speculation and proposed reform mean for healthcare ETFs? That all depends on which of the three main types of funds you’re talking about; biotech ETFs, pharmaceutical ETFs, and healthcare provider ETFs each figure to be impacted in a unique manner as this saga plays out. Each comes complete with its own risks and rewards for investing at a tumultuous time in this rapidly-changing industry.
Although biotechnology firms look to remain mostly unscathed by upcoming changes to the healthcare industry, there are some potentially troublesome revisions to patent laws that could make it much easier for certain generics to hit the market, thereby eroding the profitability of major biotech firms (and the ETFs that hold them). However, biotech drugs are very complex and many are still difficult to replicate, allowing firms to maintain their monopoly on their new drugs for a long period of time. Biotech firms could also benefit from increased government funding into preventive care (one of Obama’s preferred tactics for cutting long-term costs). Look for public/private partnerships to drive drug research in the biotechnology sector and help the major players in the industry like Gilead Sciences, Biogen, and Amgen (which also make up a sizable portion of biotechnology ETFs) to become household names like their pharmaceutical counterparts. As we’ve seen in recent weeks, biotech ETFs can make huge surges on takeover news, so the ability of larger companies to continue completing deals may be integral to the success of the industry.
Healthcare providers have been at the center of the controversy surrounding Obama’s proposed overhauls. Some argue that government involvement will help drive down costs and modernize the industry, while others believe that such a large scale “intervention” will ultimately destroy insurance companies who cannot possibly compete with the government. Another possibility is that the insurers let all of the riskiest patients go on to the government plan and attempt to keep the healthiest (and most profitable) patients for themselves, which would dramatically increase profit margins at firms such as UnitedHealth and WellPoint (who make up a significant portion of provider ETF holdings). However, it seems unlikely that insurers will be able to pull off such a scheme given the rhetoric from Democratic leaders as of late.
If upcoming legislation does indeed make it easier for generics to hit the market, big pharma could see a big hit to its profits. This push to generics, coupled with a lackluster drug pipeline, could leave pharma ETF investors reaching for the Pepto-Bismol. However, the added coverage of up to 48 million Americans who currently do not have health insurance could significantly increase the size of the market pharmaceutical customers. Also, many companies that make up pharmaceutical ETFs, such as Johnson & Johnson (which makes up nearly 25% of PPH) and Wyeth, have diversified portfolios that go beyond drugs and reach into the general consumer products category such as Purell for J&J and chapstick for Wyeth. These products are sure to sell in any type of market and provide investors with some (albeit limited) downside protection against new health care legislation.
More ETF Options
Beyond the three broad categories mentioned above, there remain a number of options for investors looking for exposure to the healthcare industry through ETFs, including:
- iShares Dow Jones U.S. Medical Devices Index Fund (IHI):IHI invests in medical device companies that generally manufacture and sell products that are critical to the healthcare industry such as stents, IVs, needles, and other hospital essentials. Since the products are somewhat outside the scope of the healthcare bill (nearly 1/4 of the fund falls in the ‘hardware’ sector), they should avoid the majority of the fallout from any new legislation.
- WisdomTree International Health Care Sector Fund (DBR): DBR invests in health care companies outside of the U.S., allowing investors to steer clear of any direct issues arising from any health care reform bill that ultimately passes through Congress. DBR is concentrated in Japan (22.9% of holdings), Switzerland (19.9%), and the UK (16.7%). Other international health care ETFs include the SPDR S&P International Health Care Secctor ETF (IRY) and the iShares S&P Global Healthcare Index Fund (IXJ). These ETFs should insulate investors from any negative developments to the U.S. healthcare system while still offering exposure to major firms such as GlaxoSmithKline, Novaris, and Bayer.
No one knows for certain exactly what (if anything) will come out of Washington once Congress returns from its summer break. But we know that the health care sector will continue to be focus, and I would anticipate that the markets may see some big swings in coming months as the debate continues to rage over the future of the industry.
Eric Dutram contributed to this article.
Disclosure: No positions at time of writing.