Health Care a Sound Investment Despite Slow Economy and Reform
Andrew Leckey

Health care investing is making a comeback in 2011.

The industry has shaken off irrational fears about reform and refocused on the opportunities that an aging population provides. Compared to industries more closely tied to the economy, it isn't scary at all anymore.

Health care and biotechnology stock funds are up 17 percent this year and 35 percent over the past 12 months, according to Lipper Inc. Their three-year annualized return is 11 percent.

Stars have emerged in healthcare:

-- Perrigo Co. (PRGO), the largest maker of store-brand pharmaceuticals sold over the counter, benefited in a weak economy from price-conscious consumers and generic releases. A large portion of this Michigan company's business is Wal-Mart stores, and about 20 percent of its sales are in international markets. Its stock is up 42 percent this year after gaining 59 percent last year.

-- Cerner Corp. (CERN), a leader in health care information technology, is bringing hospitals and physician offices into the future through its software platform that provides electronic patient, laboratory and financial information in real time. While concentrated mostly in the U.S., it has international opportunity. Its stock is up 32 percent this year after last year's 15 percent increase.

"A worsening outlook for the global economy favors defensive sectors, and health care falls into that bucket," explained Andy Oh, research analyst and portfolio manager of the $583 million Fidelity Select Pharmaceuticals Fund (FSPHX). "There are cheap valuations in health care stocks because they were underperformers the prior 12 to 18 months."

Perrigo and Cerner are stocks that Oh believes have bright futures. While health care reform will have a negative effect on the industry in the long run, the stocks were oversold on dire forecasts in 2009 and 2010, Oh believes.

"Despite the headwinds that the health care industry faces, there are ways of making money and a diversified fund is one of those," Oh said. "You don't have to worry about stock-specific risks when you put money in a health care sector fund."

His Fidelity Select Pharmaceuticals Fund has a one-year return of 34 percent and three-year annualized return of 14 percent. It holds 111 stocks, with top holdings Pfizer Inc., Johnson & Johnson, GlaxoSmithKline Plc, Valeant Pharmaceuticals International Inc., Merck & Co. and Novartis AG. This "no-load" (no sales charge) fund requires a $2,500 minimum initial investment and has a .94 percent annual expense ratio.

Wheeling and dealing among companies is revving up, a potential boost for stock prices.

"Besides the investor retreat to defensive, non-discretionary sectors, the mergers-and-acquisition activity is strong due to cheap health care valuations and companies with cash on their balance sheets," said Michael Gregory, portfolio manager of the $43 million Highland Long/Short Health care Fund (HHCAX). "With government intervention suppressing growth within companies, acquisitions are needed to fuel growth."

Big pharmaceutical companies are about to face the largest patent expiration in the industry's history and will need to fill the gap of lost income, Gregory added. Buying another company that has hot products accomplishes that rather quickly.

Gregory's Highland Long/Short Health care Fund is up 32 percent in the past 12 months and has a three-year annualized return of 30 percent. This 5.5 percent load fund's A shares require a $5,000 minimum initial investment and have an annual expense ratio of 5.92 percent. The fund takes long and short stock positions and can also invest in preferred stocks, warrants, convertible securities, debt securities and any market capitalization issued by health care companies.

Amarin Corp. Plc (AMRN), a London biotech company developing drugs for treatment of central nervous system disorders, is the sort of innovative company a big pharmaceutical company would want to acquire, Gregory believes. Its drug that lowers triglycerides has enormous sales potential, he said. Its stock is up 69 percent this year after gaining 474 percent last year.

"There are high barriers to entry in health care, and the age demographics are strongly in its favor," said Vijay Shankaran, senior portfolio manager of the $49 million Turner Medical Sciences Long/Short Fund (TMSCX). "On the negative side, health care spending is high and may not be sustainable, which means a lot of opportunity and a lot of risk."

Health care accounts for about 18 percent of the U.S. Gross Domestic Product, and such importance means investors must keep an eye on it, said Shankaran. However, it is too simplistic to say health care is a terrific industry to invest in all the time, he warned, since having exposure to its poor performance in 2009 and 2010 was not a positive experience.

Shankaran sees the cup as either half full or half empty, depending on conditions. The fact that his fund has long and short holdings enables him to "modulate" exposure to health care, in effect betting for or against it. Turner Medical Sciences Long/Short Fund, launched last February, requires a 1 percent load for its C shares, a $2,500 minimum initial investment and has a hefty annual expense ratio of 2.95 percent.

He likes stock of Allergan Inc. (AGN), which develops pharmaceuticals and medical devices. It has high visibility because its Botox dominates the neuromodulator market. If Botox receives approval to treat chronic migraines, there will be even bigger profits, Shankaran expects. Shares are up 22 percent this year after a 9 percent gain last year.

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