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A Healthcare ETF That Plays Both Offense and Defense

By Benjamin Shepherd on December 31, 2012

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At present, there are reports that a deal to avert the so-called fiscal cliff is in the midst of being finalized, though it could nevertheless face significant opposition from some House Republicans.

According to federal government data, there were nearly 50 million Medicare patients in 2012, which means they comprise one of the largest segments of insured patients in the nation. As a result, they tend to account for the majority of patients in most medical practices and a plurality in many hospitals.

Unfortunately for doctors, hospitals and other healthcare providers, Medicare reimbursements will be cut by almost 29 percent at the start of 2013 due to the fiscal cliff.

Under the spending cuts mandated by the law, if no deal is struck by New Year’s Day, Medicare reimbursements will be automatically cut by 2 percent.

While that wouldn’t be a catastrophic cut in and of itself, a law Congress passed in 1997 that ties Medicare reimbursements to overall spending and economic growth could mean doctors face a further 27 percent in cuts to reimbursements if Congress doesn’t pass what is known as a “doc fix.”

While that 1997 law was intended to be a budget control measure, the reality is that healthcare costs have long outpaced growth. So for nearly a decade now, Congress has passed a temporary funding measure each year that holds reimbursement rates at or near current levels.

The major concern for healthcare providers is that Congress is so focused on trying to dodge the fiscal cliff, it might not get around to passing a doc fix in time. The American Academy of Family Physicians says that could cost the average medical practice nearly $30,000 per year. Overall, the Medicare cuts would add up to about $120 billion over the next decade, and hospitals would bear about 40 percent of that total.

Beyond that, there are questions about how much funding the federal government will provide to states to cover Medicaid patients. The expansion of the Medicaid program, which covers mainly children and the poor, was a cornerstone of President Obama’s healthcare reform. In fact, Obamacare is expected to ultimately add at least 14 million new names to the Medicaid rolls.

But as lawmakers continue to negotiate a solution to the fiscal cliff, it’s possible that a cut in Medicaid funding will be part of any grand bargain that’s struck.

Thankfully, the news isn’t all bleak for the healthcare sector, especially if you take a global perspective.

While multinational healthcare companies have some exposure to problems in the US, there are a number of other factors that drive their profitability.

For instance, many emerging markets now boast a burgeoning middle class whose demand for healthcare has risen along with their incomes. In most emerging markets, in fact, healthcare spending is growing at an even faster rate than their economies.

While the global economic slowdown has hit economies around the world, gross domestic product (GDP) in Brazil is expected to grow by about 45 percent between 2010 and 2020. India’s GDP is expected to double during that period, while China’s GDP is projected to jump by about 115 percent.

Meanwhile, a PriceWaterhouseCoopers study predicts healthcare spending will rise 62 percent in Brazil, 140 percent in India, and more than 160 percent in China.

But best of all from an investor’s perspective, healthcare safety nets remain a concept that is largely unique to the Western world, so government spending accounts for minimal amounts of healthcare spending in these countries. That means healthcare spending won’t fall prey to politics.

Although iShares S&P Global Healthcare (NYSE: IXJ) has taken a hit as politicians wrangle over budget reform, the nearly 90 holdings in its portfolio actually have little exposure to any spending cuts in the US.

While nearly 60 percent of the fund’s assets are allocated to US-based companies–they include Johnson & Johnson (NYSE: JNJ), Pfizer (NYSE: PFE) and Merck & Co (NYSE: MR)–only about a third of the earnings generated by portfolio holdings are derived from the US.

Geographically speaking, most earnings are generated from operations in Asia and Europe. That global exposure makes the exchange-traded fund (ETF) a great defensive play if the US goes over the fiscal cliff.

The fund also offers exposure to all corners of the healthcare industry, ranging from major pharmaceutical companies to biotech names and equipment manufacturers. The inclusion of all the subsectors of the healthcare industry also helps to reduce risk from portfolio concentration.

So all things considered, iShares S&P Global Healthcare is a solid defensive holding while the political drama continues to unfold in the US, and it’s a great offensive play on growing healthcare demand overseas.

What’s New

Because of the holidays, no new funds were launched last week.

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