(PUB) Investing 2016

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The Independent Adviser for Vanguard Investors • March 2016 • 7 FOR CUSTOMER SERVICE, PLEASE CALL 800-211-7641
one-quarter of my Growth Portfolio
is invested in the sector. As a point of
reference, Total Stock Market only
has 14% in health care. My other Model
Portfolios have a similar emphasis on
health care stocks.
The stumble out of the gates has some
subscribers questioning the prudence of
having such an overweight to the sector,
so let me explain why I still have convic-
tion (and my own dollars) here.
I always like to go back to what
former Health Care manager Ed Owens
used to describe as the three-legged
stool that supported the health care
sector. It’s the best way to frame the
long-term argument for health care that
I’ve heard. And, as you’ll see, each leg
of the stool is still quite sturdy.
The first leg is demographics, which
points to increasing demand for health
care. As we get older, we tend to spend
more on health care than we did when
we were younger—and in the U.S., a
quarter of a million people turn 65 each
month. But this isn’t just a U.S. story;
in Japan and Europe, populations are
growing older as well.
The second leg of the stool is glo-
balization. The U.S. outspends the rest
of the world on health care by a large
margin. While this might mean that we
could be more efficient in our spend-
ing, it also suggests there is a lot of
room for the rest of the world to spend
increasing amounts of money on health
care. This is particularly true in emerg-
ing economies, where the middle class
continues to grow. Remember, one of
the first things consumers spend on
as their wealth increases is better and
more health care.
The third growth driver for the
health care sector is R&D, which leads
to new product development. Biotech
and medical device companies can be
risky investments in their early years,
but if their drugs work or their products
deliver as expected, then the payoffs
can be huge. Plus, if these biotech and
medical device companies are success-
ful, we could all be living a lot longer,
which ties back into the first part of the
story about demographics and the ris-
ing demand for health care.
Two more points here. First, health
care is a very broad and diverse sector,
one which can play both defense and
offense. I wouldn’t say health care is
immune to recessions, but it tends to
be recession-resistant. When times get
tough, people keep spending on health
care—when you are sick, you visit the
doctor. And that means prescriptions
and over-the-counter remedies remain
in demand. Additionally, the big phar-
maceutical companies are large and
stable, and have historically held up
well when the stock market stumbles;
they also pay dividends.
One last piece of the puzzle here
is top-notch active management. Ed
Owens put together a truly remarkable
record at Health Care from its May
1984 inception through his retirement
at the end of 2012. Former co-manager
Jean Hynes has ably taken the reins,
and she has not missed a beat, outpac-
ing Health Care ETF by 2.5% a year
since the end of 2012.
The team at PRIMECAP Manage-
ment isn’t too shabby at picking stocks
in the sector, either.
The big question mark hanging
over the sector—political action and
reform—is only likely to heat up over
the next year, but that’s all the more rea-
son to partner with an active manager
rather than simply decide to invest in
the sector through an index fund. I sus-
pect we’ll mostly just get rhetorical and
political posturing, but if Washington
actually does pass or repeal heath care-
related legislation (a big “if”), there
will be winners and losers—just as
there were when the Affordable Care
Act was put into law. If anything, the
political uncertainty is likely to create
a nice buying opportunity—both for
Jean Hynes and the PRIMECAP team
buying individual stocks—as well as
for investors like you and me looking
to ride the long-term health care wave.
Now, don’t forget that Health Care
had been on a particularly nice run
over the past several years—at the end
of 2015, it had outpaced Total Stock
Market by 9.6% per year over the prior
five years. It was only a matter of time
until the sector and fund took a breather.
And that’s all I think this is—a breather.
Take a look at the relative perfor-
mance chart to the left, which shows
the long-term performance of both
Health Care and the MSCI Health Care
Index, upon which Vanguard’s health
care index fund and ETF are based,
versus 500 Index. What you can see
(particularly when looking at the active
fund) is that despite some periods when
the market outperformed, the long-term
returns and overwhelming steadiness of
Health Care has more than won the day.
At some point, Health Care and the
health care sector will lag the broad
stock market. It’s happened before and
will happen again, as the chart shows.
In fact, during the first part of the post-
Financial Crisis stock market rally,
Health Care lagged by a good amount,
and some investors began to question
their and my commitment to the sector.
It’s true that one sector cannot outper-
form all the time, or eventually it would
become the market. It would be great if
we could time those ups and downs, but
I don’t think anyone knows how to do
that—it’s certainly outside of my circle
of competence. And while we shouldn’t
expect Health Care’s 20%-a-year pace to
persist forever, the long-term tailwinds
of demographics, globalization and new
product development remain strong.
I don’t know how long the lag by
health care stocks will last, but I’m
sticking with the sector, and in par-
ticular with Jean Hynes and her team
on Health Care. I suggest you do so as
well, and if you have some spare cash
available or don’t have at least a 5%
position in the fund, that you use this
opportunity to add to your holdings.
You won’t be disappointed. n
Health Care vs. 500 Index
1/94 1/961/981/001/021/041/06 1/081/101/121/141/16
0.00
0.50
1.00
1.50
2.00
2.50
3.00
3.50
4.00 Rising line = Health Care or the MSCI Health Care
Index outperform 500 Index
Health Care vs. 500 Index
Health Care Index vs. 500 Index