Mutual funds specializing in health care stocks have performed poorly in recent years but that may be about to change.
A key factor limiting performance has been the 40-per-cent gain in the Canadian dollar versus the U.S. dollar during the past four years.
Since most of North America’s primary care, pharmaceutical and biotech stocks are listed on U.S. exchanges, the rise in the Canadian dollar exchange rate has effectively made those stocks less valuable to Canadian shareholders.
An example that illustrates the exchange rate impact is the CI Global Health Sciences Fund, which in the past three years has returned after fees an average annual 15.04 per cent in U.S. dollars but only 10.22 per cent in Canadian dollars.
Another example is the Fidelity Focus Health Care Fund, whose three-year average annual U.S.-dollar performance of 11.34 per cent was shrunk to 6.65 per cent by the exchange rate move.
Little wonder that GlobeFund’s ranking shows no health-care funds at the top five-star level. The CI Global Health Sciences Fund is four-star and the other healthcare mutual funds available to Canadians rank still lower.
The mediocre performance in Canadian-dollar terms provides little support on the surface for the recommendation that Canadians should go global in their investing to take advantage of key sectors like pharmaceuticals and biotech, which are poorly represented in Canada.
However, it could be beneficial for investors to dig a little deeper in their analysis. With Canada’s manufacturing industries and trade balance being severely diminished, it is likely that the value of the Canadian dollar has already peaked in this cycle.
Assuming no drag coming from the Canadian dollar in the future, Canadian investors will reap the full reward of investing in global health care funds.
The risk-reward profile of the different funds can vary quite widely. Those more heavily invested in pharmaceuticals can show drastically different results and volatility than those emphasizing higher-risk biotechnology stocks or more-stable primary care companies.
Picking winners among pharmaceutical and biotech stocks can be very difficult. There are long lead times in drug development and just one bad result in Phase I, II or III trials can knock a stock back severely.
For most investors, it makes sense to diversify broadly and that usually means leaving the stock picking to a mutual fund manager.
However, most mutual funds have management fees of 2.5 to 3 per cent annually, an important drag on performance.
In their search for low-fee investing, some investors are attracted to index-linked exchange traded funds (ETFs) specializing in biotechs. Annual expense ratios range from 0.35 to 0.6 per cent. These are traded on the American Stock Exchange and warrant a serious look.
The largest ETF is the iShares Nasdaq Biotech Fund (symbol IBB), a $1.7 billion (U.S.) fund. It is up 2.94 per cent over the past year. Among its holdings are Amgen, Gilead Sciences, Teva Pharmaceutical, Celgene, Genzyme, Biogen Idec, Vertex Pharmaceuticals and so on.
The next largest is the Biotech HOLDRS Trust (BBH), a $1.5 billion fund holding a variety of health care stocks chosen by Merrill Lunch, its sponsor. It holds such companies as Genentech, Amgen, Gilead and Genzyme and 15 others. The trust is down 7.57 per cent over the past year.
The PowerShares Dynamic Biotech and Genome Portfolio (PBE), a $259 million fund that holds such companies as Applied Biosystems, Waters Corp., Amgen, Gilead, Biogen Idec, New River Pharmaceuticals, and Genentech. The fund gained 6.18 per cent over the past 12 months.
Two other smaller ETFs are the First Trust Amex Biotechnology Index (FBT), which holds more junior biotechs with high volatility, and the SPDR Biotech Fund (XBI). Both were initiated less than a year ago.
One would be excused for saying, “Why bother?” given the above-mentioned funds’ anemic returns versus the S&P 500’s 13.8-per-cent gain over one year.
Specialty sector stocks can languish for years before catching a powerful wave. By going with an index-linked ETF, you would be setting up to surf that wave, whenever it comes.
But given the history of volatility and high rate of failures among biotech firms, a better route to investing in this sector may be to go with an active manager who understands the science and through smart choices can produce steady returns even when the sector is in the doldrums.
Wayne Cheveldayoff is a former investment advisor and professional financial planner. He is currently specializing in financial communications and investor relations at Wertheim + Co. in Toronto. His columns are archived at www.smartinvesting.ca and he can be contacted at wcheveldayoff@yahoo.ca.
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©2006 Wayne Cheveldayoff