The Pharma Four: Similar ETFs, Different Returns

by on October 17, 2011 | ETFs Mentioned:

Pharmaceutical companies have long been popular investments as they offer relatively inelastic products as well as strong dividend yields that give both growth and value investors something to buy into. As far as the ETF world is concerned, there are four products that allow investors to gain access to this investment class. But with the four products being very similar, it can be difficult to pick and choose one ETF over the other. While underlying holdings or investment strategies may be similar, the returns of these products has been drastically different over the last few years, which may swing investors one way or the other on these ETFs [see also Three Things Wall Street Journal Didn’t Tell You About Commodities].

HOLDRS Merrill Lynch Pharmaceutical (PPH)

This HOLDRS fund debuted in 2000 and is an investor favorite, with nearly $500 million in assets and an average daily volume well over 300,000. As a HOLDRS product, the fund has never changed or rebalanced its underlying holdings, allowing investors to always know what they are buying into. PPH’s top holdings include a who’s who of big pharma companies with Johnson & Johnson, Pfizer, Merck, and Abbott making up a combined 70% of the ETP. PPH pays out a healthy dividend yield of 4.4% with a beta score of just 0.72, making it a stable but reliable product for a portfolio.

Looking at trailing returns, PPH has fared well since it exited its recessionary drop. The fund has gained 2.9% on the year but is relatively flat in the trailing 52 week period. Looking further to its three year return, the 23% gains along with a robust dividend yield make PPH a fund that demands a closer look. Note that Van Eck will be taking over the line of HOLDRS products, and PPH will converted into an index-based product sometime in the near future [see also ETF Shakeup: HOLDRS Headed For Extinction, ELEMENTS To Follow?].

SPDR S&P Pharmaceuticals ETF (XPH)

This fund tracks an index that represents the pharmaceuticals sub-industry portion of the S&P Total Markets Index. As such, top holdings in the ETF include Bristol-Myers, Eli Lilly, Merk, and Johnson & Johnson. In contrast to PPH, this fund weights most of its securities the same, with no single holding getting an allocation higher than 4.5%. XPH features a beta of 0.99 and pays out a dividend yield that is just below 1% [see also 25 Ways To Invest In Silver].

When it comes to returns, it seems that XPH’s weighting strategy has paid off, as the fund is up roughly 6.3% in 2011 and 6% in the trailing year. As for three year returns, this product returned a jaw-dropping 103%, and that’s nothing compared to its returns of 47% for the five year period; in a time when all major indexes and most asset classes bottomed out, this ETF held its ground to post steady gains.

Dow Jones U.S. Pharmaceutical Index Fund (IHE)

This ETF, from iShares, seeks to replicate a benchmark that measures the performance of the pharmaceuticals sector of the U.S. equity market. The fund has about $235 million in assets and an average daily volume around 50,000, giving decent liquidity, but certainly not the best in the space. IHE’s top holdings are nearly identical to the order of PPH’s though where PPH overweights its top four, those same four companies make up just 34% of the overall fund in IHE’s case. This ETF pays out a current 30 Day SEC Yield of 1.49% [see also Top 5 Free ETF Tools On ETFdb.com].

As far as returns go, IHE guns for the top spot, with YTD earnings of 9.4% and over 9.8% over the trailing year. Its three year is no joke either, with over 88% gained since October of 2008. It would appear that IHE’s strategy to not overweight any one component has served it well.

Dynamic Pharmaceuticals Portfolio (PJP)

This product takes a unique approach with a quasi-active indexing strategy. PJP follows an index that is designed to provide capital appreciation by thoroughly evaluating companies based on a variety of investment merit criteria, including fundamental growth, stock valuation, investment timeliness and risk factors. The fund has a total of 30 holdings, with no single company receiving a higher weight than 5%. Note that PJP has a significant amount of both small and large cap exposure, giving it a unique risk/return profile. This indexing strategy comes at a price, however, of 60 basis points, a bit higher than the previous three [see also Alternatives To The 20 Most Popular ETFs].

PJP is the undeniable winner for recent returns, as its one year performance of 18% nearly doubles the next closest competitor. 2011 has seen the fund rake in nearly 11% as well as an astounding 93% over the last three years. For the time being, the indexing strategy developed by PowerShares seems to be outdoing the competition.

The Pharma Four: Returns
Ticker YTD 1 Year 3 Year
PPH 2.89%  0.52%  23.03% 
XPH 6.29%  6.07%  103.05% 
IHE 9.35%  9.84%  88.27% 
PJP 10.89%  18.04%  93.40% 

Verdict

While no one fund is better than the other, a clear pattern has emerged. Those funds that elected to keep their weightings in check, and not allocate too much to any one company have cleared fared better than the rest. While it remains to be seen if this is just due to weakness in some of the major firms in the sector which have faced issues from patent cliffs or law troubles, it does highlight the need for diversification in the space. It also should suggest to many that understanding the holdings of a particular product is key and that rebalancing schemes– or the lack thereof– can play a huge roll in the performance of a product, especially in these rocky markets.

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Disclosure: Photo courtesy of David Richfield. Jared is long PFE.