As we move into 2020, health care equities could be poised to outperform.

A rebound would be a major change from a dismal 2019. After a strong 2017 and 2018, the sector has lagged the market overall (up only 5% vs. the S&P 500's 20%); health care mutual funds and ETFs have seen $13 billion in net outflows through September, compared to $1.5 billion in inflows through all of 2018, according to Morningstar Direct data, per The Wall Street Journal. Although health care equities are usually a solid defensive play, the attacks on the industry by Democratic presidential candidates—some of whose proposals would virtually eliminate private insurers and/or change industry business models—and ongoing opioid-related lawsuits have spooked investors.

Still, many companies are offering solid balance sheets, attractive dividend yields, and upbeat outlooks, and in fact, solid Q3 earnings reports have helped the sector rally in the final months of 2019. Demographic-fueled demand is on the rise for healthcare products and services, and companies in this sector are flush with cash—all of which means better dividend yields and even stock buybacks that enhance shareholder value.

So, now might be the perfect time to dip your toes into the healthcare market while prices are still discounted—though questions about the future of the Affordable Care Act and what might replace it are likely to keep the sector volatile throughout the election year. These three top healthcare exchange-traded funds (ETFs) could be ready to gain on a bullish market. All figures were current as of Dec. 6, 2019.

key takeaways

  • Though depressed in 2019 by courtroom proceedings and campaign promises, the health care sector could be poised to outperform in 2020.
  • Three leading health care ETFs are SPDR's Health Care Select Sector fund and S&P Biotech fund, and Vanguard's Health Care Index Fund.

Health Care Select Sector SPDR ETF (XLV)

  • Issuer: State Street Global Advisors
  • 2018 performance: 6.30%
  • 2019 YTD performance: 16.82%
  • Net assets: $19.18 billion
  • Expense ratio: 0.13%

XLV tracks the healthcare stocks in the S&P 500, weighted by market cap. It is the oldest fund in this segment and by far the largest. As a reflection of the U.S. healthcare market, this fund is hard to beat. It stands head and shoulders above its peers by nearly every metric—including liquidity and holding costs.

Of course, drawing from the S&P 500, the fund is heavily weighted toward mega caps—think Johnson & Johnson (JNJ), Merck & Co. (MRK), Pfizer Inc. (PFE), and UnitedHealth Group Incorporated (UNH). XLV is fairly concentrated, with the top 10 holdings making up 51.5% of the total assets in the fund's all-equity portfolio. XLV's one-year, three-year and five-year annualized returns are solid at 8.73%, 15.27%, and 8.75%, respectively. 

Vanguard Health Care Index Fund (VHT)

  • Issuer: Vanguard
  • 2018 performance: 5.55%
  • 2019 YTD performance: 18.39%
  • Net assets: $10.93 billion
  • Expense ratio: 0.10%

Cheap and diversified, VHT holds 372 equities comprising the MSCI U.S. Investable Market Health Care 25/50 Index. It pulls healthcare stocks—pharmaceuticals, biotech, medical equipment, software, and IT—from the top 98% of the total U.S. stock market capitalization. The ETF is still somewhat concentrated, however, with the top 10 holdings accounting for over 43% of the fund's portfolio.

As with all Vanguard funds, VHT publishes its holdings only once a month, so there's less transparency compared with other funds. However, for buy-and-hold investors, that's rarely a problem. VHT offers broad exposure to the healthcare sector with a very friendly price tag. Its one-year, three-year and five-year annualized returns are 7.28%, 15.59%, and 9.6%, respectively. 

SPDR S&P Biotech ETF (XBI)

  • Issuer: State Street Global Advisors
  • 2018 performance: -14.90%
  • 2019 YTD performance: 23.38%
  • Net assets: $5.89 billion
  • Expense ratio: 0.35%

Following the S&P Biotechnology Select Industry Index, this fund takes a novel approach to the U.S. biotech sector: It equal weights its portfolio, so performance is more tightly tied to small-cap companies, some of which have yet to bring a drug to market. The approach appears to be working, however, since XBI's impressive one-year, three-year and five-year annualized returns (14.72%, 14.53%, and 9.68%, respectively) are crushing the competition.

Though more volatile than other funds, XBI is relatively efficient for a straight sector play that tilts toward small caps. There are currently 114 equities in its basket of holdings, and the top 10 holdings account for just 22.3% of the fund's portfolio.