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Time is on health care sector's side

With life expectancy increasing, the global population will consume more drugs

Rolling Stones guitarist Keith Richards' fall from a coconut tree last spring should have made a thud in the health care sector -- but it didn't. The 62-year-old bad boy's tumble and resulting concussion was a blunt reminder to investors that baby boomers have entered their sixties and are living longer, more active lives. And if they keep climbing coconut trees, that means more spending on health care.

While "Keef" made a full recovery, the benchmark Globe Health Care Peer Index continued drifting through its five-year coma, which has resulted in a 4.4-per-cent average drop in value each year. It's only been in the past month or so that health care started showing signs of life. Since late June health care stocks have advanced more than 7 per cent, compared with a modest 3-per-cent increase for the broader S&P 500 index.

The gain can partly be attributed to some positive reports from equities analysts such as UBS Securities. In a note to clients, the global strategy and asset allocation specialist recommended loading up on U.S. large caps, with a special focus on health care.

Last month's blip on the sector's electrocardiogram should be welcome news for health care mutual fund holders who have suffered an average annual loss of 3 per cent over the same five-year period. For the past decade investors have been told the sector will take flight as the first wave of the postwar generation reaches retirement. Recent advances in the health care field have been pushing life expectancy rates forward, which means a large chunk of the global population will consume more health care products over a longer period of time.

The nearly 40 health care funds available on the Canadian market have lagged the index but one fund to catch the recent rally is Talvest Global Health Care. Fund managers from Wellington Management Co. have boosted the value of the fund more than 5 per cent during the past month thanks to large holdings in pharmaceutical giants such Schering-Plough Corp. and Eli Lilly & Co.

For some fund managers with the ability to pick the right health care stocks the sector has been creeping forward for quite a while. The top-performing fund in the sector so far this year is the CI Global Health Science Corporate Class Fund with a return of 5.3 per cent. Portfolio manager Andrew Waight has handily beaten the group average and the index, posting a five-year annual average return of nearly 10 per cent.

"I do see demographics as a good tailwind for this sector," says Mr. Waight, who has been managing the fund since 2000. Like most health care funds, the bulk of the portfolio is invested in the United States. He says the top holding, ImClone Systems Inc., sums up his investment strategy because it has the growth potential of a biotech company and the stability of a pharmaceutical giant. "Big drug companies usually do well in a market slowdown. Biotech does better when the market has an appetite for risk," he says.

Other big pharma holdings in the CI Global Health Science Fund include Bristol Myers Squibb Co., GlaxoSmithKline PLC and Sanofi-Aventis. On the growth side Mr. Waight sees potential in Genentech Inc. -- a company that uses human genetic information to develop drugs for a wide range of medical conditions including a treatment that cuts off the blood supply to cancer cells. "Innovation is a big factor," he says.

Some direct demographic plays in the fund are retirement homes including Manor Care Inc., which Mr. Waight says could be getting a little overvalued for investors looking to get in right now.

He advises retail investors to keep their own health care weighting between 5 and 10 per cent, and be patient. He's bullish on the sector over next 12 months but is concerned the 2008 U.S. election could bring a Democratic government with a leaning toward universal health care. It is feared that government intervention in the health sector could cut into corporate profits and drive down stock prices.

Other health care funds performing well so far this year are R Life & Health with a return of 3.1 per cent, and Mackenzie Universal Health Science with a year-to-date return of 3.1 per cent. Laggards include CI Global Biotechnology Corporate Class, which is down 13.1 per cent, and TD Health Sciences GIF II -- down 7.1 per cent.

Investors who want direct exposure to the big-name health care stocks can choose between two health care exchange-traded funds. The iShares Dow Jones U.S. Healthcare Fund (IYH) trades on the New York Stock Exchange and the iShares S&P Global Healthcare Sector Fund (IXJ) trades on the American Stock Exchange.

It's little surprise health care fund managers are big on the sector but many broader U.S. equity fund managers are overweighting their portfolios beyond the 13-per-cent total market capitalization represented by health care. RBC U.S. Equity Fund manager Brad Willock says it is necessary to commit 25 to 33 per cent of a diversified portfolio to health care to get the right names. "Generally, the sector call is not as important as getting the right names," he says.

Mr. Willock says he doesn't need to be sold on the demographic argument over health care. According to his figures, health care consumption for most people doubles when they turn 60 and quadruples when they turn 80. He says an aging population combined with the current obesity epidemic makes health care a simple call. "The first of the boomers are in the sweet spot right now," he says.

The RBC U.S. Equity fund currently invests about 13 per cent of its $1.6-billion in assets in the health care sector with an eye on increasing the weighting as opportunities arise. The health care portion itself is a mix of big pharma names including Wyeth and Eli Lilly & Co. as well as smaller pharmaceutical stocks such as Baxter International Inc. and Abbot Laboratories. On the growth side Mr. Willock has positions in biotech companies Genzyme Corp. and Celgene Corp. One company of note in the portfolio is Gilead Sciences Inc., which specializes in a drug delivery technology used to treat AIDS patients -- more commonly known as an AIDS cocktail.

Demographics aside, Mr. Willock is also raising his stake in the health care sector -- along with utilities, telecom and consumer staples -- as a brace against an expected downturn in the U.S. economy. "The health care sector has historically been defensive and we're concerned about the U.S. economy," he says. One economic red flag that has Mr. Willock concerned is the growing U.S. debt and its potential impact on the overall financial health of the U.S. economy.

Most U.S. equity funds have health care weightings under 15 per cent but a few have raised their stake in the sector according to the latest information released by the fund companies. Some of the funds with the highest health care weightings include: AGF U.S. Risk Managed Class (24.8 per cent), London Life U.S. Growth Sector (20.4 per cent), Maritime Life U.S. Equity-R (18.8 per cent), BMO U.S. Growth (18.6 per cent) and US Equity Diversified Pool (18.6 per cent).

One U.S. equity fund manager who is avoiding the health care sector like the plague is James Cole from AIC Funds. His AIC American Focused fund has a tiny 0.5-per-cent weighting in health care, which comprises a single stock -- Health Management Associates Inc. HMA provides acute care health services in non-urban communities across the southeastern and southwestern United States.

HMA is clearly a demographic play but Mr. Cole generally views biotechnology and pharmaceutical stocks as too risky. "The big drug companies are subject to the same risks as the entire technology sector . . . patent expiration, litigation risks and unpredictable cash flows," he says.

One example that highlights his point is the recent U.S. court ruling against Mississauga-based Biovail Corp. This week, Biovail lost a battle to protect its patent on its Wellbutrin XL antidepressant -- one of its key drugs. As a result, Biovail announced it will review its financial guidance for the entire year. Biovail stock fell 17 per cent on the day the court ruling was announced.

Mr. Cole has invested the bulk of his $1-billion portfolio on financials services and consumer discretionary stocks. As for health care, he says the sector is too diverse and unpredictable to even forecast. "I'm reluctant to give an outlook for the health care sector because there are so many subsectors," he says.

Dale Jackson is a producer at Report on Business Television.

Boomernomics

7,918

The projected number of Americans turning 60 each day in 2006.

Health care heavyweights

U.S. Equity Funds with high health care weightings (as of July, 2006)

Funds
1. AGF U.S. Risk Managed Class24.8%
2. London Life U.S. Growth Sector20.4%
3. Maritime Life U.S. Equity-R18.8%
4. BMO U.S. Growth18.6%
5. US Equity Diversified Pool18.6%

I do see demographics as a good tailwind for this sector.

ANDREW WAIGHT,

CI GLOBAL HEALTH SCIENCE FUND MANAGER

The first of the boomers are in the sweet spot.

BRAD WILLOCK,

RBC U.S. EQUITY FUND MANAGER

The big drug companies are subject to the same risks as the entire technology sector . . . patent expiration, litigation risks and unpredictable cash flows.

JAMES COLE,

AIC AMERICAN FOCUSED FUND MANAGER

© 2007 The Globe and Mail. All rights reserved.

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