Good Funds with Big Health-Care Exposure

Health care has been in the news a lot lately. Democrats in Washington have been working for months to push through health-care reform legislation, and late last year they passed separate bills in the House and Senate that still have to be combined into a single bill. Now Republican Scott Brown's victory in the January 19 special election for Ted Kennedy's old Senate seat has thrown a wrench in their plans. Brown will be the Republicans' 41st vote in the Senate, allowing them to filibuster the combined bill and prevent it from coming to a vote. Health-care reform isn't dead, but it now looks more difficult for Democrats to achieve.

Financial markets pay a lot of attention to what's happening in Washington, especially these days. Uncertainty over the status of reform was a big reason health-care stocks underperformed the market in 2009, and the stocks of big health insurers jumped ahead of the election when polls showed that a Brown victory was likely. There are plenty of other factors affecting health-care stocks, but right now the political ones are on the front burner.

Despite the uncertainty, some smart fund managers are fans of health-care stocks.  Fairholme (FAIRX), managed by newly minted Morningstar Manager of the Year (and Manager of the Decade) Bruce Berkowitz, had more than one third of its stock assets in health care as of Aug. 31, 2009. At 13% of assets,  Pfizer (PFE) was the top holding, and  Humana (HUM) and  Forest Laboratories  also cracked the top 10.

A number of other excellent funds have more than 20% in health-care stocks, including  Vanguard Primecap (VPMCX) (and four other funds run by the same managers),  Dodge & Cox Stock (DODGX), and  Jensen (JENSX). However, most of these funds' health-care exposure comes from drugmakers and biotech stocks rather than health insurers such as  WellPoint (WLP) and Humana, which are most directly affected by the proposed health-care reform bill.

What about funds with direct exposure to the insurers? We looked at diversified funds (i.e. not including health-care sector funds) with at least $100 million in assets, and the following table shows the 10 with the highest percentage of their portfolio in the health-care plans industry, with each fund's category, size, and percentile ranking in its category so far in 2010 (as of January 21) and in 2009.

Diversified Funds with Big Health-Insurer Stakes

This is an interesting and diverse group. The funds' performance was all over the map in 2009, but most of them have beaten their categories in the first few weeks of 2010. Fairholme once again shows up at the top of the chart, and it has been one of the best-performing large-blend funds so far in the new year. As noted above, health insurer Humana was among the fund's top 10 holdings in its most recent portfolio, which also included WellPoint,  UnitedHealth Group (UNH), and WellCare Health Plans . As of early December, Berkowitz had trimmed the latter names and added to Humana because he expected it to fare better under health-care reform, but it remains to be seen whether the new developments will affect his thinking.

Other funds here are worth noting.  Torray (TORYX) manager Bob Torray focuses on strong businesses with good cash flows and reasonable valuations, and he tends to hold onto stocks for a long time. That approach didn't work particularly well in the go-go market of 2009, but the fund's top-10 positions in WellPoint and UnitedHealth (both of which are up more than 10% so far in 2010) have helped it to a top-quartile ranking in the new year.

 Legg Mason Value (LMVTX) is run by former Morningstar Fund Manager of the Year Bill Miller, who beat the S&P 500 benchmark for 15 straight calendar years before badly trailing it each year from 2006 through 2008. Miller's bold contrarian approach is responsible for the fund's highs as well as its lows and helped the fund bounce back strongly over the past 10 months thanks to big stakes in financials and technology. Health insurers  Aetna  and UnitedHealth are among the fund's top holdings, as is supplementary insurer  Aflac (AFL), which has risen along with the health insurers recently.

 Legg Mason ClearBridge Aggressive Growth (SHRAX) is run by Richie Freeman, another manager with bold convictions and a strong long-term record. After struggling in recent years, the fund has been on fire the past few months thanks to its big overweightings in media, energy, and health-care stocks, which together make up three fourths of assets. The fund's health-insurer stake comes entirely from top-five holding UnitedHealth, but biotech firms  Amgen (AMGN),  Biogen Idec (BIIB), and  Genzyme  are also among its top holdings.

Finally, there's  Fidelity Low-Priced Stock (FLPSX). Longtime manager Joel Tillinghast has compiled one of the best long-term records in the business despite the fund's huge asset base. While most of the other funds on this list have fairly concentrated portfolios (eight of the 10 hold fewer than 70 different stocks), this fund holds more than 800 stocks. But its top holding as of October 31 was UnitedHealth, at 2.8% of assets, and its 5.7% stake in health insurers is by far the biggest of any industry. To the extent that this very diversified fund can be said to have industry bets, health insurers seem to be one area that Tillinghast likes.