Healthy Exchange-Traded Funds

With populations steadily getting older, the health-care sector might be the place to focus if you're looking for healthy returns. In 2006, the oldest of the baby boomers turned 60, the leading edge of an estimated nearly 80 million boomers. By 2030, the U.S. Census Bureau estimates there will still be roughly 58 million boomers kicking around.

Regardless of how much they exercise or how much they spend on plastic surgery, this huge chunk of the population just keeps getting older. This is good news for the U.S. health-care industry, which stands to benefit from the boomers' golden years. In a nation that spends more dollars per capita on health care than any other country, there are obviously many investment opportunities. But you still should be careful to invest your money wisely.

ETFs coming to market
Sponsors of exchange-traded funds have not been blind to the health-care sector. Roughly a dozen firms have come to market with funds, giving investors more than 40 health-care ETFs to choose from. Options range from broad market funds covering the sector in the United States and around the world to funds that narrow the focus to industry subgroups. Others slice the market into thin segments represented by as few as a couple dozen securities.

ETFs are traded on an exchange like stocks.

Most health-care ETFs have one feature in common: Their holdings are weighted by market cap. That means larger, well-known names will appear in their portfolios more frequently. But a few fund families use different approaches. HealthShares funds are weighted equally so that individual stocks will not dominate the holdings. That seems a sensible approach to such narrowly invested funds. PowerShares offers fundamentally weighted funds and selects stocks based on four fundamental measures: sales, cash flow, book value, and dividends. And WisdomTree focuses on dividend-paying companies, based on the belief that dividends are an objective way to measure value since they are difficult to manipulate.

Many health-care ETFs are fairly new; HealthShares alone came to market at different times throughout 2007 with 20 funds. Short operating histories can make it difficult to gauge how a fund is likely to perform in the future.

Broadly diversified funds
Sticking to broadly diversified funds is the best way to get started in this sector. Both the Vanguard Health Care ETF (AMEX:VHT) and iShares Dow Jones U.S. Healthcare Sector Index Fund (NYSE:IYH) are well-diversified funds, with expense ratios of 0.24% and 0.48%, respectively. Both of these funds have been around for a couple of years, which gives them tenure in this young space. The iShares fund has returned 7.29% in the past year, with a three-year average of 7.74%, and a five-year average of 7.67%. The Vanguard fund is younger, with one- and three-year returns of 7.45% and 8.30%.

Over the border
Developed countries such as Japan and Germany are also dealing with aging populations and concurrent increases in demand for health care. Investors who want to venture outside the U.S. have several diversified ETFs to consider. The WisdomTree International Healthcare Sector Fund (NYSE:DBR) combines an international investment strategy with a focus on dividend-paying stocks. The fund tracks the WisdomTree International Health Care Sector Index, which measures the performance of dividend-paying companies in developed markets outside the U.S. and Canada. Companies in the index are weighted based on cash dividends paid and come from the health-care products and services industries, as well as the pharmaceutical and biotechnology industries. The fund has a total return since its late-2006 inception of 8.88%, and carries a 0.58% expense ratio. The fund has about 21% of its assets invested in U.K. companies, with another 20% in Japan and about 16% in Switzerland.

The iShares S&P Global Health Care Sector Index Fund (NYSE:IXJ) tracks the S&P Global Health Care Sector Index, which includes health-care providers, biotech companies, and companies involved with medical supplies, advanced medical devices, and pharmaceuticals. The fund has been around since late 2001 and has one-, three-, and five-year annualized total returns of 3.36%, 8.38% and 7.97%, respectively.

Narrowing your focus
If you want look at a particular subsector or theme, there are a number of funds to choose from. In a drug-crazy nation like the U.S., it makes sense to look at pharmaceuticals. The SPDR S&P Pharmaceuticals ETF (AMEX:XPH) tracks the S&P Pharmaceuticals Select Industry Index. It holds only 21 stocks, but none of them constitutes more than 6% of the fund. Just over a year old, the fund has a return of 5.87%. The fund comes with a moderate 0.35% expense ratio.

With cancer an ever-present danger, the HealthShares Cancer ETF (NYSE:HHK) is an interesting investment. The fund tracks the HealthShares Cancer Index and invests in health care, life sciences, and/or biotechnology companies that have been identified as cancer companies. The fund does come with a significantly higher expense ratio of 0.75%. Also, it's only six months old -- too short a period to evaluate.

Do your research and start with well-diversified funds and know that there are strong fundamental reasons why an allocation to this sector is likely to be a beneficial and healthy choice for your portfolio.

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