FHLC: Because A Healthy Investor Holds Health Care Stocks (NYSEARCA:FHLC)

My followers know that I advise all investors to build and hold a well-diversified portfolio throughout the market’s up-n-down cycles. In my previous Seeking Alpha articles on portfolio management, I have discussed how some core sector holdings can play an important role in such a portfolio. I personally have allocated capital to the consumer staples, utilities, and technology sectors via ETFs like the (XLP), the (XLU), and (FTEC), respectively. Today I am going to discuss another important sector holding of mine: the Fidelity MSCI Health Care Index ETF (NYSEARCA:FHLC).

Investment Thesis

In challenging markets (like the bear-market of 2022), investors tend to search out defensive sectors, for example: consumer staples, utilities, defense & aerospace, and health care. The healthcare sector is viewed as a defensive and inflation resistant sector because many healthcare issues cannot be delayed and also because healthcare providers can typically pass on increased inflationary costs directly through to the consumer (or to the insurance company that represents that consumer). Indeed, over the past year the FHLC ETF outperformed the S&P500 by ~12.2%:

Considering that inflation is still high, the Federal Reserve is still in a rising interest rate posture, and the war in Ukraine keeps raging on, investors are probably still looking at the Healthcare Sector to be somewhat of a shelter-in-the-storm.

In addition, the demographics for the Healthcare Sector are quite compelling:

As you can see from the graphic, the number of Americans aged 65+ have been growing rapidly and are expected to continue to do so through 2040 and beyond. The number of Americans aged 85 and older is projected to more than double from 6.6 million in 2019 to 14.4 million in 2040 (a 118% increase). Older people obviously require more healthcare. That being the case, today I’ll take a look at the FHLC ETF to see how it has positioned investors for long-term success in the Healthcare Sector.

Top-10 Holdings

The top-10 holdings in the FHLC ETF are shown below and were taken directly from the Fidelity FHLC ETF webpage (investors can click on that link and find more detailed information on the fund). The top-10 holdings equate to a relatively moderately diversified 48.6% of the entire 448 company portfolio:

The #1 holding is diversified healthcare behemoth UnitedHealth Group (UNH) with a 8.4% weight. UNH stock is up 4.7% over the past year, but closed down 1.23% Friday on the heels of Q4 results that beat consensus estimates. Non-GAAP EPS came in at $5.34/share while revenue of $82.8 billion was +12.3% yoy (a $270 million beat). UNH pays a $6.60 annual dividend, but the $489 stock only yields 1.35%.

Johnson & Johnson (JNJ) is the #2 holding with a 7.9% weight. JNJ is a diversified healthcare company that makes such well-known consumer brands such as Listerine, Aveeno and Neutrogena skin health/beauty products, Tylenol, Sudafed, Benadryl, and Motrin – among many others. JNJ stock is up 2.2% over the past year and yields 2.61%.

Big-pharma is well represented in the FHLC’s top-10 list with Eli Lilly (LLY), Pfizer (PFE), AbbVie (ABBV), Merck (MRK), and Bristol Myers Squibb (BMY) holding down the #3-#6 and #10 positions, respectively, and together equate to 22.2% of the entire portfolio. Lilly is up 44.8% over the past year, while Pfizer is down 13.8%. ABBV yields 3.85%, Merck 2.6%, and BMY yields 3.14%.

The #9 holding is diverse medical, commercial, and industrial device maker Danaher Corp (DHR) with a 3.1% weight. Danaher’s stock has gained 174% over the past 5-year. DHR trades with a forward P/E = 26x and yields only 0.37% with a $1/share annual dividend.

Performance

The FHLC ETF has an admirable 5-year average annual return of 11.57%:

The fund’s inception was in October of 2013, and therefore won’t have a 10-year performance track record until later this year. Morningstar has given the fund a 4-star rating, and the following graphic compares FHLC’s 5-year total returns with some of its peers: the Health Care Select Sector SPDR (XLV), the Vanguard Health Care ETF (VHT), and the iShares U.S. Healthcare ETF (IYH):

As you can see from the graphic, other than the SPDR Healthcare ETF XLV – which has outperformed – the other three ETFs are grouped around a 65-66% 5-year total return range. The XLV ETF’s expense ratio (0.10%) is a couple basis points higher than FHLC’s (0.08%), but the yield is also higher (1.47% vs 1.30%).

Risks

While Health Care is generally considered to be a defensively oriented sector, it is still not immune to the overall economic environment: high inflation, a still very active Covid-19 pandemic, higher interest rates, and the negative impact that Putin’s war-of-choice on Ukraine is having on the global economy. Any – or all of these – could combine to push the U.S. and/or the global economy into recession and negatively affect the stocks held in the FHLC ETF.

Summary & Conclusions

The health care sector is relatively diverse – with everything from medical device & equipment makers, to pharmaceutical drug makers, healthcare providers, and consumer goods manufacturers. The demographics – with a highly growing older age population – are quite constructive for the sector going forward.

Given the relatively low yield (1.30%), the primary investment opportunity here is capital appreciation – not income.

I don’t see any short-term catalyst for the healthcare group, and will reiterate my HOLD rating on FHLC. That said, investors looking to establish a diversified position in the healthcare sector – either via FHLC or perhaps the XLV ETF – I suggest adding them to your watch list to try and take advantage of market volatility to slowly average into the funds – over time – on market weakness.

I’ll end with a 5-year total returns comparison of the FHLC and XLV healthcare ETFs with the broad market averages as represented by the Vanguard S&P 500 ETF (VOO) and the Nasdaq-100 (QQQ) and note that – despite the 2022 bear-market – the triple Qs still lead the pack: