3 Gold-Rated Funds Whose Managers Love Healthcare Stocks

Healthcare stocks have been a drag in 2023. The sector’s 7.8% loss through Oct. 31 fell more than 18 percentage points shy of the Morningstar US Large-Mid Cap Index’s 10.7% gain. The sector also lags the broader index over trailing three- and five-year periods, and the effect extends and expands down-cap: Healthcare stocks in the Morningstar US Small Cap Extended Index fell an annualized 14.5% over the past three years, almost 20 percentage points behind the broad small-cap index’s 5.4% annualized gain.

When a sector catches a cold, the funds that lean heavily on it sneeze, to turn a phrase around. We look at three funds whose managers love healthcare—a prescription for recent underperformance. While one has delivered decent returns in 2023, they all earn Morningstar Medalist Ratings of Gold, and there are plenty of reasons to think they’ll outperform over longer periods.

Vanguard Capital Opportunity VHCAX

This fund’s healthcare allocation of 32.8% was nearly 3 times that of its Russell 1000 Growth Index and more than 12 percentage points over that of the Russell Midcap Growth Index. Subadvisor Primecap’s approach resists classification, as the portfolio regularly holds stocks across the market-cap spectrum while walking the line between growth and blend. The roughly 180-stock portfolio is an amalgam of five managers’ separately run sleeves, yet it traces a well-worn path in biotechnology stocks. Biotech shares ate up 13.7% of assets in September versus 2.8% for the Russell 1000 Growth, while drugmakers’ stocks claimed another 13.5% of the portfolio but just 2.8% of the index.

In 2023, the healthcare allocation detracted from relative performance, as the fund’s 9.9% gain fell far short of the benchmark index’s 23.2%, putting it near the lowest quintile of funds in the large-growth Morningstar Category as the negative effects of biotech outpaced the benefits from pharma stocks. While healthcare can also drag over longer periods, this fund has delivered for investors overall, trouncing relevant indexes as well as rivals over the past two decades.

WCM Focused International Growth WCMRX

This strategy’s quality-growth orientation leads it to favor healthcare and information technology stocks. Its 18.8% healthcare stake was nearly 6 percentage points more than the MSCI ACWI ex USA Growth Index’s allocation as of September. That was down considerably from July 2022, when its 27% healthcare helping was more than twice the index’s. Its healthcare overweighting—and more so its tech picks—have led to this fund’s middling peer-relative performance over 2023, which is unusual for this strong strategy. Its 0.3% gain topped the index’s 1.4% decline but still fell slightly below the median foreign large-growth category peer. Within healthcare, life sciences hurt the most, including off-benchmark holding Mettler-Toledo MTD, which makes weighing and other lab instruments.

This highly rated team has led this and its three other strategies to significant outperformance over the long haul, so it’s plenty capable of turning around its current peer-relative slump.

Brown Capital Management Small Company BCSIX

While investors may hope the first two funds will rebound soon, this fund has already done so. After healthcare helped sink its relative performance in 2022, it’s come back true to form in 2023.

This small-growth team, led by Brown’s CEO and CIO Keith Lee, seeks innovative firms with differentiated products, strong competitive positions, and capable executives who can deliver long-term growth. That leads them to overweight tech and healthcare stocks, with the latter having claimed 29.5% of assets as of September, about 8 percentage points higher than that of the Russell 2000 Growth Index. That allocation hit 37.8% in mid-2022, more than 15 points higher than the benchmark at the time, even as growth stocks were crashing. Over all of last year, the healthcare allocation trailed only information technology in terms of biggest drags, with the life sciences industry being the biggest culprit. The fund’s 38% loss for the year trailed the benchmark by more than 11 percentage points, landing it in the worst decile for the small-growth category.

But 2023 has been much different. While life sciences stocks have still restrained returns, the fund’s 0.4% loss through October easily beat the benchmark’s 2.9% decline, good for a category ranking near the top quartile. Its healthcare allocation detracted, but good stock-picking mostly nullified the effect.

The article was published in the October 2023 issue of Morningstar FundInvestor. Download a complimentary copy of Morningstar FundInvestor by visiting the website.