These funds offer thoughtful investments in healthcare, not tactical plays.
This article was originally published in the November 2016 issue of Morningstar FundInvestor. After its release, the results of the presidential election prompted a brief surge in healthcare stocks. However, while the typical health-sector fund gained 3.7% in November, it was still down 10.4% for the year through Dec. 11, even as all other domestic sector and diversified stock fund categories remained well in the black. Download a complimentary copy of FundInvestor here.
Healthcare funds were down 13.4% for the year through Oct. 31, following a big rally in prior years. Morningstar's stock analysts see opportunities here: They expect pricing power for drug and biotech companies to remain strong, research and development to remain productive, and mergers and acquisitions to continue at a steady pace.
Heavy sector concentrations always come with risk. That said, a long-term bet on the broad growth opportunities in the healthcare sector is not the same level of risk as, say, a tactical precious-metals play (as attractive as such a play might seem in hindsight at the moment). We ranked Morningstar Medalists in the Morningstar 500 by their healthcare positions and found eight domestic-equity funds with more than a fourth of assets staked there. All of them fall within a growth category.
ClearBridge Aggressive Growth SHRAX had the biggest stake at one third of assets. This isn't a new stake in this high-conviction portfolio: Biogen BIIB, UnitedHealth Group UNH, Allergan AGN, and Amgen AMGN, all among the top holdings at the end of September, were originally purchased in the 1990s. (Although Allergan, previously Actavis, entered the portfolio in 2014, it did so after buying longtime holding Forest Laboratories.) These four picks alone made up about one fourth of assets, and the fund's 35% healthcare weighting was approximately twice that of its Russell 3000 Growth Index benchmark and the large-growth Morningstar Category. The fund, which has a Morningstar Analyst Rating of Silver, is more volatile than peers, but it has paid off over the long term.
Four of these are Gold-rated funds run by the Primecap team that won the Morningstar Domestic-Stock Fund Manager of the Year accolade in 2014 and back in 2003: Primecap Odyssey Growth POGRX (a large-growth fund with a 33% healthcare stake); Vanguard Capital Opportunity VHCOX (large growth, 32%); Primecap Odyssey Aggressive Growth POAGX (mid-growth, 30%); and Vanguard Primecap VPMCX(large growth, 27%). The funds are all variants of the same patient contrarian growth strategy. The Primecap team's strategy paid off in a big way in 2014: Big Biotech and Pharma holdings in all the funds--such as Biogen, Amgen, Eli Lilly LLY, Roche RHHBY, and Novartis NVS--posted strong returns for the second-straight year. The team has long argued that the market was underestimating the pipelines and growth potential of these firms, and it still stands by these picks. The Primecap approach can experience periodic slumps, but it has produced superior long-term results.
Bronze-rated Amana Growth AMAGX has among the best 15-year returns in the large-growth category, and it has been one of the least volatile funds in the category, thanks to longtime manager Nick Kaiser's preference for stable growers and his willingness to hold cash in tough times. This is despite the fund's pronounced sector tilts. It is one of a handful of North American mutual funds that hews to Islamic principles, which exclude essentially all financials, as well as high-debt companies, which applies to many real estate, telecom, energy, and utilities names. Not surprisingly, the fund typically holds more in technology and healthcare than its average peer, with longtime holding Amgen at more than 4% of assets and the biggest pick in its 26% healthcare stake as of Sept. 30.
Two small-cap growth funds also made the list, with healthcare stakes just above 25%: Gold-rated Brown Capital Management Small Company BCSIX and Silver-rated Conestoga Small Cap CCASX. (The former remains closed to the new investors, while the latter reopened earlier this year.) While healthcare companies are generally riskier in the small-cap space, both funds are run by experienced teams that emphasize quality, and their risk has been moderate relative to the small-growth category. The portfolios have little overlap, but Bio-Techne TECH and Abaxis ABAX are names in common.