Health Care Plan Poses Risks for ETFs
As the Senate took the U.S. one step closer to national health care on Sunday, some ETFs in the sector could face a second round of Obama-inspired losses. As billions of new taxes are levied on insurers, large pharmaceutical companies and medical device makers, health care subsector exchange-traded funds will face different challenges.
The increasingly likely health care law could smother recent gains seen by medical devices and pharmaceutical ETFs, like the iShares Dow Jones U.S. Medical Devices(IHI) and iShares Dow Jones U.S. Pharmaceuticals(IHE).
ETFs that track health care providers, like the iShares Dow Jones U.S. Healthcare Providers (IHF), and biotech companies, like the iShares Nasdaq Biotechnology ETF(IBB), may already have seen the worst of their losses.
The initial hit to health care ETFs came in the wake of President Obama’s election. As plans for sweeping reform materialized, ETFs across health care’s subsectors were impacted. In 2008, IHI and IHE dropped 36.79% and 14.91%, respectively.
IHF, which tracks health care providers like UnitedHealth Group(UNH) and WellPoint(WLP), fell 43.46%, while IBB fell 12.28%.
In 2009, as health care reform appeared to be sinking while the market recovered, health care ETFs reversed course. Year to date, IHI and IHE are up 35.74% and 27.89%, respectively.
IHF and IBB also have been on the upswing in 2009. Year to date, IHF is up 34.85% while IBB has increased 11.68%.
While the broad spectrum of narrowly focused health care ETFs have, thus far, moved as a group, the transformation and passage of the health care reform bill could send these funds in different directions.
Now, the objective of health care ETF investors is to determine which health care sectors already have the impact of the bill priced in.
The “public option,” or government insurance alternative, has been stripped out of the Senate’s version of the bill, and the existing employer-based health-insurance system is basically left untouched. While new fees will be harmful to the insurance providers in IHF’s portfolio, the absence of a government-alternative health-insurance plan is good news for the holders of this fund. IHF will probably not see another 35% gain in 2010, but it will likely avoid disastrous losses similar to 2008.
Biotechnology, the least-harmed subsector in 2008, has the potential for gains in 2010. Biotech firms, tracked by ETFs like IBB, are largely hit-or-miss operations working to develop cutting-edge technologies. If a company hits the proverbial biotech lottery, the blockbuster drugs are often sold off to Big Pharma.
This critical difference between biotechnology and pharma is what will help biotech and hurt pharma when the new bill hits the industry. The new health care bill focuses on cutting costs, implementing reforms that will emphasize generics and hurt Big Pharma’s profits.
Many biotech drugs, on the other hand, offer unique benefits to small groups of patients. This specialization will minimize the leverage that pharmacy-benefit managers have over drug firms as the two groups battle over cost-cuts.
Medical device manufacturers, like the companies tracked by IHI, face a tougher road ahead. Cuts to Medicare, which currently reimburses many medical device companies, coupled with new taxes, could harm this subsector. IHI’s volatile journey through 2008 and 2009 could continue in 2010.
Investors have been bracing themselves for the impact of Obama’s health care initiatives for some time now. Public options, public opinion and politics have helped to shape the course of health care ETFs over the last two years.
Just as economic crisis and reform speculation have produced a herding effect in these funds in 2008 and 2009, the passage of the health care bill may produce a divergence of health care’s subsector ETFs in 2010.
