Fidelity Healthcare Fund: 5 Things You Should Know

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The Fidelity Select Health Care Fund (FSPHX 0.40%) is one of the best performing Fidelity mutual funds, helped by the strong performance of healthcare stocks, and stock selection that puts it among the top healthcare mutual funds on the market. But before you buy this fund, there are a few things you should know about its portfolio, performance, and reported dividend.

1. The fund's mandate and manager

The Fidelity Select Health Care Fund has a broad mandate to invest at least 80% of its assets in companies that engage in the "design, manufacture, or sale of products or services" that are used in healthcare or medicine. In practice, virtually all of the fund is invested in companies that have a strong connection to the healthcare industry. 

Notably, Edward Yoon, the fund's current portfolio manager, also serves as manager of the Fidelity Medical Equipment and Systems Portfolio as well as co-manager of Fidelity Health Care Services Portfolio. The Fidelity Select Health Care Fund is the least selective of the three funds, given that it can broadly shop for bargains across a wide pool of healthcare stocks.

2. What it actually owns

Its largest investments by subsector were biotechnology (29.3%), healthcare equipment (27.2%), and pharmaceuticals (20.3%). These are arguably the kinds of business lines that investors generally think about when they think of healthcare stocks.

It recently reported having positions in 105 different companies, though it doesn't shy away from large bets on companies in which it has high conviction. Here's a breakdown of the fund's five largest individual investments.

Data source: Fidelity, as of Sept. 30, 2016.

Note that the fund management runs its portfolio in a much less diversified fashion than other managers. The top five holdings of T. Rowe Price and Vanguard healthcare funds made up only 18.1% and 27.5% of fund assets, respectively. 

Of course, the argument can be made that this is what investors expect -- if you're paying for the smarts of the portfolio manager, then the portfolio manager should use those smarts to bet bigger on his or her best ideas. Nevertheless, there is a consequence to portfolio concentration. The movements of just five stocks have an outsize impact on the performance of this Fidelity fund.

For the sector purists of the world, you'll be happy to know that Fidelity's fund doesn't get distracted with quasi-healthcare businesses such as those that own senior living facilities or hospital buildings, for example, which are only tangentially related to healthcare and have lower-return business models.

3. Performance vs. other healthcare mutual funds

Over multi-year periods, performance has been excellent when contrasted with other healthcare funds and stocks as a whole. Annualized returns over three-, five-, and 10-year periods are below, as well as its rank within the Morningstar healthcare category.

Data source: Morningstar.

4. Fees and expenses

For an actively managed sector fund, the Fidelity Select Health Care Fund is hardly out of the norm. The fund carries an expense ratio of 0.73%, slightly less than sector funds' asset-weighted average expense ratio of 0.78%, according to the Investment Company Institute.

There are less-expensive alternatives. Vanguard's actively managed fund carried an expense ratio of 0.36% at the time of writing. The primary difference is that Vanguard's healthcare fund is more heavily invested in established pharmaceutical companies and less invested in biotech stocks. Fidelity's fund carries significantly more biotech exposure, and less pharmaceutical exposure, as discussed.

Outside the world of actively managed funds, healthcare ETFs are plentiful. Expense ratios for some of the best healthcare ETFs dip as low as 0.09% per year.

5. Don't buy this healthcare fund for the dividends

Unfortunately, many investors have been attracted to healthcare mutual funds because of their apparently high distribution yields. The majority of healthcare fund distributions in the recent past do not reflect a steady-state level of income on which investors can rely.

In 2015, the fund made capital gains distributions totaling $24.20, which led many to believe that the fund was paying out a "yield" that topped 10%. In fact, many mutual fund screeners and online finance portals reported the yield to be that high. In reality, the fund was simply passing on capital gains from selling stocks over the course of the year, not dividends earned from the stocks in its portfolio.

The last time the fund paid a true dividend distribution was in 2013, in the amount of $0.034 per share, which was then worth about $156. This is not a high-yield fund, as many biotechnology and pharmaceutical companies, which make up about half the fund, pay no or low dividends to their shareholders.

All in all, the fund has historically been an above-average performer at a roughly average expense ratio. For those who believe that an active manager can add value in the complicated world of healthcare, it should easily rank as a top fund for investors interested in the industry.