Yardeni Research, an investment advisory firm specializing in in-depth empirical and analytical research, released a report on Feb. 4 highlighting the healthcare sector as the best performer year-to-date of the 10 sectors that represent the S&P 500. Up 6.9% year-to-date, retail investors are finally getting back into the markets. To take advantage of the momentum in healthcare, let's look at four ETFs that will help you do just that.

Top Investment Trends For 2013: We go over a few investment trends for you to think about for 2013.

The Biggest
One of the 100 largest ETFs in terms of assets, the Health Care Select Sector SPDR Fund (ARCA:XLV), is State Street's (NYSE:STT) answer to a diversified healthcare portfolio. Over 14 years old, the ETF has $5.9 billion in total net assets with average daily volume of 6 million shares. Liquidity is not a problem. Consisting of 53 holdings averaging $84 billion in market cap, these are generally some of America's finest healthcare companies. The largest holding is Johnson & Johnson (NYSE:JNJ) with a weighting of 12.48%, followed closely by Pfizer (NYSE:PFE) at 12.16%. Its top 10 holdings represent 57% of the portfolio. Of that 57%, pharmaceutical companies represent a little more than three-quarters of the $3.4 billion in assets. A bet on the XLV is a bet on Big Pharma.

Put aside the pharmaceutical bent for a moment and consider some of the things that make XLV a great investment. When investing in ETFs, there are several things to keep in mind, and none more important than low fees. XLV's annual expense ratio is 0.18%, lower than all healthcare ETFs with the exception of the Vanguard Health Care ETF (ARCA:VHT), which is four basis points (BPS) lower. Just as with mutual funds, the headwind created by higher fees can be the difference between good long-term returns and mediocre ones.

However, fees aren't the only thing that matters. Flat-out performance is also critical, and in this regard the XLF is just so-so. Over the past 10 years, its annualized total return is 6.9%, 170 and 100 BPS less than the healthcare category and the SPDR S&P 500 ETF (ARCA:SPY), respectively. Considering SPY's annual expense ratio is 8 BPS less than XLV should give you pause before jumping in. The biggest problem with XLV is that in the years it underperforms the SPY, it does so by a significant amount. Anyone looking for low volatility might not want to go down this road.

According to ETF Database, five ETFs are available with the word "pharma" in the fund name. Since the XLV is pharmaceutically focused, it makes sense to determine if any of the five can do what it does plus more. The first important detail is that none of the five options have a 10-year track record. However, three have a five-year track record: iShares Dow Jones U.S. Pharmaceuticals Fund (ARCA:IHE), SPDR S&P Pharmaceuticals ETF (ARCA:XPH) and PowerShares Dynamic Pharmaceuticals Fund (ARCA:PJP). IHE is 100% invested in pharmaceutical companies; XPH is at 98%; and PJP is at 77%. All three have a higher pharmaceutical component than XLV at 48% of its portfolio.

None of the trio can hold a candle to XLV when it comes to management fees, where the closest is SPDR at 0.35% annually. However, when it comes to performance, despite having the highest annual expense ratio at 0.60%, PJP has the best five-year record with an annualized total return of 16.9%, 250 BPS higher than the XPH. The XLV doesn't even make double digits.

Interestingly, the PowerShares fund has the lowest pharmaceutical component of the three alternatives, providing investors with some industry diversification despite a pharma-centric approach. Replicating the performance of the Dynamic Pharmaceuticals Intellidex Index, the 30 stocks are selected using a combination of growth and value criteria. With just 30 holdings, investors should keep in mind that a smaller portfolio cuts both ways; future performance might not match past performance due to the additional company risk associated with fewer stocks.

Equally Important
ETFs are generally market cap-weighted, equally weighted or fundamentally weighted. Of the three, I prefer equally weighted funds because it provides better representation from top to bottom than the more commonly used market-cap weighting, which puts a premium on the top 10 holdings. Anyone who's owned a market cap-weighted ETF with Apple (Nasdaq:AAPL) as the top holding has witnessed firsthand how this affects performance. However, owning an equally weighted ETF can also be a win/lose proposition. You lose when a stock like Apple goes on a big run; but as we've seen recently, it cuts the other way as well.

The Guggenheim S&P 500 Equal Weight Healthcare ETF (ARCA:RYH) is meant to replicate the performance of the S&P 500 Equal Weight Health Care Index, which when you boil it down is really just the same 53 stocks that make up the XLV, only in much different weightings. The top 10 holdings in RYH account for just 21% of its $99 million in total assets compared to 57% for the XLV.

The No.1 holding in the equal-weight fund is Boston Scientific (NYSE:BSX) at 2.34%, while the smallest holding is Merck & Co. (NYSE:MRK) at 1.64%. In the XLV, Merck is the third-largest holding with a weighting of 7.56%. The two funds are like night and day. In terms of performance, there's no comparison. RYH has a total return of 76.2% since its inception in November 2006; the XLV's return in the same six-year period is just 42.7%. Guggenheim's fund wins by hitting singles and doubles while the XLV is swinging for the fences.

SEE: 3 Types of Indexing For ETF Success

Smaller Is Better
Boston Scientific started out as a smaller, more entrepreneurial company, as did most other healthcare companies. Some grow to be mid caps, some to be large caps and an exclusive few become giant caps like Johnson & Johnson (NYSE:JNJ) or Pfizer. All it takes is for one small cap to become a giant cap, and your investment returns spike exponentially. Not to mention small caps provide some of the more interesting corporate histories. Sure, they also come with more risk, but the potential rewards are greater too. If you want to capture healthcare, owning small caps is an important piece of the puzzle.

The PowerShares S&P SmallCap Health Care Fund (Nasdaq:PSCH) is a group of 67 healthcare stocks that are part of the S&P SmallCap 600 Index. The ETF is market cap-weighted with the top 10 holdings accounting for 36% of its $110 million in total net assets. As you scroll through a list of its holdings, unless you spend a lot of time studying the markets, many of the names won't ring a bell. That's OK. ETFs are meant for just such an occasion. Diversification, especially when you're dealing with smaller companies, is vital to your success.

The PSCH has been around since April 2010. Since that time, it has seriously underperformed its large-cap brethren mentioned previously. That's a good thing, because when the XLV begins to cool, the small-cap ETF will ride to the rescue. Best of all, its annual expense ratio is a very reasonable 0.29%. You would think when dealing in smaller, less liquid stocks, costs would be higher, but that's not the case. You don't want to bet a huge amount, but 25% of your healthcare investment wouldn't be a bad call.

The Bottom Line
If it were my $10,000 on the line, I'd invest $7,500 in the Guggenheim S&P 500 Equal Weight Health Care ETF and $2,500 in the PowerShares S&P SmallCap Health Care portfolio. By doing so, you cover all the bases.

At the time of writing, Will Ashworth did not own any shares in any company mentioned in this article.

Related Articles
  1. Personal Finance

    A Day in the Life of an Equity Research Analyst

    What does an equity research analyst do on an everyday basis?
  2. Mutual Funds & ETFs

    ETF Analysis: ProShares UltraPro Nasdaq Biotech

    Obtain information about an ETF offerings that provides leveraged exposure to the biotechnology industry, the ProShares UltraPro Nasdaq Biotech Fund.
  3. Mutual Funds & ETFs

    ETF Analysis: iShares MSCI Europe Financials

    Learn about the iShares MSCI Europe Financials fund, which invests in numerous European financial industries, such as banks, insurance and real estate.
  4. Mutual Funds & ETFs

    ETF Analysis: SPDR S&P Insurance

    Learn about the SPDR S&P Insurance exchange-traded fund, which follows the S&P Insurance Select Industry Index by investing in equities of U.S. insurers.
  5. Mutual Funds & ETFs

    ETF Analysis: SPDR S&P Emerging Markets Small Cap

    Learn about the SPDR S&P Emerging Markets Small Cap exchange-traded fund, which invests in small-cap firms traded at the emerging equity markets.
  6. Mutual Funds & ETFs

    ETF Analysis: ETFS Physical Platinum

    Learn about the physical platinum ETF. Platinum embarked on a bull market from 2001 to 2011, climbing to record prices along with other precious metals.
  7. Mutual Funds & ETFs

    ETF Analysis: iShares MSCI Turkey

    Learn about the iShares MSCI Turkey exchange-traded fund, which invests in a wide variety of companies' equities traded on Turkish exchanges.
  8. Mutual Funds & ETFs

    ETF Analysis: PowerShares S&P 500 Downside Hedged

    Find out about the PowerShares S&P 500 Downside Hedged ETF, and learn detailed information about characteristics, suitability and recommendations of it.
  9. Mutual Funds & ETFs

    ETF Analysis: Guggenheim Enhanced Short Dur

    Find out about the Guggenheim Enhanced Short Duration ETF, and learn detailed information about this fund that focuses on fixed-income securities.
  10. Mutual Funds & ETFs

    ETF Analysis: iShares US Oil&Gas Explor&Prodtn

    Learn about the iShares U.S. Oil & Gas Exploration & Production ETF, which provides an efficient way to invest in the exploration and production sector.
  1. Equity

    The value of an asset less the value of all liabilities on that ...
  2. Exchange-Traded Fund (ETF)

    A security that tracks an index, a commodity or a basket of assets ...
  3. Exchange-Traded Mutual Funds (ETMF)

    Investopedia explains the definition of exchange-traded mutual ...
  4. Hard-To-Sell Asset

    An asset that is extremely difficult to dispose of either due ...
  5. Sucker Yield

    When an investor has essentially risked all of his capital for ...
  6. Lion economies

    A nickname given to Africa's growing economies.
  1. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  2. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  3. What does a high turnover ratio signify for an investment fund?

    If an investment fund has a high turnover ratio, it indicates it replaces most or all of its holdings over a one-year period. ... Read Full Answer >>
  4. Does index trading increase market vulnerability?

    The rise of index trading may increase the overall vulnerability of the stock market due to increased correlations between ... Read Full Answer >>
  5. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
  6. What types of capital are not considered share capital?

    The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >>

You May Also Like

Trading Center

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!