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Funds Ailing Over Managed-Care Stocks

The industry has been hurt several ways this year.

David Kathman, 04/15/2008

This year has been a tough one so far for many segments of the market, but arguably no industry has been beaten up as badly as managed care, that is, health insurers and related businesses such as pharmacy benefit managers. The average managed-care stock had lost 27.68% for the year to date through April 8, making it one of the worst-performing industries out of the 129 that Morningstar tracks. This may seem surprising at first glance, because health-care stocks are supposed to do well in tough economic times, but managed-care stocks have been hit from several different directions.

For one thing, the U.S. presidential election has brought health-care reform to the forefront of public discussion, with all the candidates proposing major changes that could hurt the existing insurers. On top of that, rising medical costs have been cutting into these firms' profit margins, leading to some high-profile reductions in earnings forecasts. Such fears, combined with company-specific issues, have taken a major toll on all the major managed-care players. The industry's two largest companies, UnitedHealth Group UNH and WellPoint WLP, are down 35% and 47% respectively for the year to date through April 8, and most of their competitors are down at least by double digits.

These big managed-care stocks are widely held by mutual funds, with health-care sector funds being affected most directly. One such fund, Fidelity Select Medical Delivery FSHCX, has 40% of its portfolio in managed-care stocks, and its 24% loss for the year to date through April 8 is by far the worst in the health-care category. The second-biggest managed-care stake, at 28%, belongs to ICON Healthcare ICHCX, which (not coincidentally) also has the second-worst year-to-date record in the health-care category. The next three funds in the ranking are also health-care sector funds--BlackRock Healthcare MDHCX, AllianceBernstein Global Health Care AHLAX, and Munder Healthcare MFHYX--and all are also among the category's worst performers this year.

Some diversified stock funds also have significant managed-care stakes, and the effect there has been similar. The following table shows the 10 diversified funds with the largest percentage of their portfolio in managed-care stocks, along with each fund's category, size, and percentile ranking within its category for the year to date through April 8. As usual, we've excluded funds that are clones of other funds on the list.

 Biggest Managed-Care Bets


Managed Care % % Rank
Cat 6 Mo.
Piedmont Select Equity PSVFX
Lg Growth
16.9 15.40 78
Legg Mason Partners All Cap SPAAX
Lg Growth
801.9 13.55 99
DWS Equity Partners FLEPX
Lg Blend
274.5 13.22 96
Lg Growth
137.3 12.10 95
Fidelity Large Cap Growth FSLGX
Lg Growth
148.2 11.99 92
Natixis Westpeak 130/30 Grth NEFCX
Lg Growth
40.0 11.77 87
Legg Mason Value LMVTX
Lg Blend
13,289.4 11.13 99
White Oak Select Growth WOGSX
Lg Growth
334.6 10.45 98
Dunham Large Cap Growth DALGX
Lg Growth
73.8 10.45 44
JHFunds2 Core Equity NAV JHCRX
Lg Growth
851.6 10.14 99

As the last column shows, these funds have been struggling mightily this year. Seven of the 10 are ranked in their category's bottom decile, and only Dunham Large Cap Growth DALGX is ranked better than the bottom quartile. Managed-care stocks aren't solely responsible for all this underperformance, but they've certainly contributed to it. All of these funds have double-digit stakes in the industry, and each has at least one managed-care stock among its top 10 holdings.

One other thing that many of these funds have in common is a contrarian streak, which draws them to stocks that for one reason or another are beaten down--temporarily, the managers hope. The most prominent such fund on this list is the legendary Bill Miller's Legg Mason Value LMVTX, which has UnitedHealth and Aetna AET among its top five holdings. Miller got a lot of attention for his streak of 15 straight years beating the S&P 500 benchmark, but since that streak ended two years ago, almost nothing has gone right for the fund. A series of ill-timed bets on industries such as homebuilders and mortgage lenders caused the fund to trail 99% of the large-blend category in both 2006 and 2007, and it's in similarly bad shape this year.

We still like Miller and his fund as a long-term investment, despite the ugly short-term results. The same goes for some of the other funds on this list with similarly concentrated contrarian-growth portfolios, such as Legg Mason Partners All Cap SPAAX, run by Jay Leopold in Milleresque fashion, and DWS Equity Partners FLEPX, managed by Hoby Buppert. Of course, none of this is any guarantee that managed-care stocks will rebound anytime soon, because all of these managers have been wrong before, and some of the other funds have so-so records. However, it's worth noting that Morningstar's stock analysts consider some of these stocks very undervalued right now, with UnitedHealth and WellPoint both sporting 5-star Morningstar Ratings as of April 9. Also, investing based on political expectations is often a dicey proposition; there's no guarantee that these companies will be affected by health-care reform as much as the market fears.

David Kathman is a fund analyst with Morningstar

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