Health-Care Funds Hit a Rough Patch
What’s ailing health-care funds?
After a four-year run that produced an average annual return of almost 30%, the category is down about 15% so far in 2001, according to fund tracker Morningstar Inc.
The funds started their ascent in the mid-1990s after the threat of Clinton-era price controls on health care faded. But this year, several factors are crimping performance, according to fund managers.
Among the problems: Stock valuations had gotten lofty as drug makers and biotech upstarts rallied sharply in 2000, and major patent expirations are clouding the profit outlook at some drug giants, such as Merck (ticker symbol: MRK).
Most of all, managers say, investors have shifted their attention to “cyclical” sectors and away from so-called defensive industries such as health care as the Federal Reserve’s interest-rate cuts have stoked hopes for economic recovery.
However, they say demographic trends tied to the world’s aging population and, more important, continuing scientific advances still make health care a lucrative long-term bet.
“The health sector is very sound fundamentally. I think what we’re seeing is basically sector rotation,” said manager Thomas Wald, whose Invesco Health Sciences fund is down 16.8% this year.
While patent expirations are a concern, managers say that some of the big drug makers have other strong products in the works.
“It’s not like we can’t see these things coming,” said Samuel D. Isaly, whose Eaton Vance Worldwide Health Sciences fund is down nearly 11% this year, but has the best 10-year annualized return in its sector at 22.2%. “Take Eli Lilly [LLY]. Despite the well-publicized expiration of Prozac, we like the company’s [drug development] pipeline a lot.”
What’s more, the market slide that sent key stock indexes to two-year lows in early April has brought share valuations down, managers note.
Isaly built a stake in Immunex (IMNX) a few weeks ago, for example, when the price fell to its lowest since 1999 after a product disappointment.
James Fenger, whose Scudder Health Care Fund is down 15.7% this year after gaining 59.8% in 2000, said medical supply firms, in particular, are trading at attractive valuations. He said he has added to his stakes in Baxter International (BAX) and Abbott Labs (ABT), two companies with potential growth catalysts: in Baxter’s case, a new hemophilia product, and in Abbott’s, the pending acquisition of a German company that owns an arthritis-treatment product.
Invesco’s Wald said he has bought stocks such as Genentech (DNA), MedImmune (MEDI) and IDEC Pharmaceuticals (IDPH). Such stocks typically trade at high valuations, but he noted that MedImmune’s price-to-earnings ratio fell to about 30 in March based on estimated 2001 earnings.
Still, some managers acknowledge that health care could get left behind in the second half of the year if the economy perks up.
“If the economy stays soft, investors probably will gravitate back to health care. But if it picks up, other growth areas may reap the immediate rewards,” Wald said.
As many investors have shifted their attention away from the most speculative stocks and back toward underlying company fundamentals, health-care fund managers say they are emphasizing profitability in their portfolios.
Isaly said most of his unprofitable companies will soon hit the black: Cor Therapeutics (CORR) this year, for instance; Gilead Sciences (GILD) and Caliper Technologies (CALP) in 2002.
“Some people have likened biotech to the disenchanted dot-com world, but I think it’s night and day,” Fenger said. “Here you have very high barriers to entry. It takes a long time to develop products. You have patent protections. And you know what’s already out there. Plus, the pharmaceutical industry has the highest [operating profit] margins in the U.S.”
He said he also likes hospital stocks, which account for about 10% of his portfolio. He pointed to his holdings in Tenet Healthcare (THC) and HCA-The Healthcare Co. (HCA), both of which had positive earnings surprises recently.
Wald said one area he steered clear of is HMOs. He is skeptical of their ability to continue raising prices roughly 10% a year, as they have been doing the last few years.
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A Pullback After a Long Advance
Mutual funds that focus on health-care stocks have been one of the worst-performing fund sectors this year, but the losses follow a strong year in 2000 and decent returns for most of the late 1990s.
Average annual total returns for health-care sector funds
Through Friday: -14.9%
Source: Morningstar
