Health, biotech funds are good -- but volatile

MUTUAL FUNDS

July 07, 1991|By WERNER RENBERG | WERNER RENBERG,1991 Werner Renberg

When you see mutual fund performance data for periods that ended June 30, you've got to be impressed by the showing of the handful of health/biotechnology funds.

The group outperformed all others, on average, for the latest year and ranked a close second for both the latest five-year and six-month periods, according to Lipper Analytical Services.

In the latest year, its total return of 31.8 percent was more than double that of the second-place financial services group. And it was 11 times the average for all equity funds.

Moreover, health/biotechnology funds were prominent among the top 25 of all equity funds for each of the periods. In fact, five made the list for the latest five years, led by the Financial Funds' Health Sciences Portfolio, which ranked first among all funds. It had an exceptional average annual total return of 24.7 percent.

If you've been along for the ride in one of these funds and watched the slippage in the second quarter, you may wonder whether to take your profits, to hold on, or even to add to your position. If you missed out on the surge, you may wonder whether you could make money by investing now -- and, if so, in which fund.

In weighing the pros and cons of investment in such funds, bear in mind that the group's share prices are volatile because the funds are subject to both stock market and industry risk.

Prices of their stock holdings decline when the market falls. Because the funds are primarily invested in stocks for their appreciation potential, they don't own enough dividend-paying stocks to provide an income cushion during down markets. (Some have little or nothing left from their dividend and interest receipts after providing for operating expenses, and pay no dividends at all.)

In addition, the funds' concentration in the mammoth health card industry exposes them to its problems -- whether due to government policies and regulations, product obsolescence, litigation arising from product liability, or competition -- regardless of how diversified their investments may be within this economic sector.

Those who have accepted these risks have been rewarded in recent times, as the table illustrates. With some exceptions, such as hospital management companies suffering from a profit margin squeeze, earnings of companies in the industry have enjoyed solid growth.

Then, too, fears of the recession led many investors to bid up stock prices of companies in industries, such as health care, that usually are less affected by an economic slowdown. And shares of many smaller companies in the industry got an extra boost from renewed investor interest in companies having small capitalizations or low revenues.

Can the appreciation of health care industry stock prices be sustained, providing continued buoyancy for health care funds?

Think about the factors that could make it possible -- provided that overall market conditions are favorable. Two stand out:

* Health care accounts for about one-eighth of the gross national product, according to some estimates, and its share is increasing, partly because of the aging of our population and partly because of our dedication to conquering diseases and improving the quality of life.

* The health care industry is developing new products, services and processes at a rapid rate, enabling companies to benefit from the higher profit margins that are often earned in the early years.

John Kaweske, portfolio manager of Financial Health Sciences (and also of Financial Industrial Income Fund, ranked No. 10 for the last 10 years), says he is especially "sanguine" about prospects of a theme he has begun to invest in: innovation resulting from the widespread efforts to contain medical costs.This has led him to buy into a variety of companies -- from those selling drugs by mail to companies providing outpatient surgery and home-infusion therapy in place of hospitals.

When comparing funds for compatibility with your goals and risk tolerance, it may be helpful to see how their assets are allocated among the industry's broad classifications: drugs; medical supplies, equipment, and services; operation of hospitals, health maintenance organizations, and other facilities; and biotechnology. Drug stocks tend to be less volatile and often pay dividends. Biotechnology stocks tend to be most volatile; some companies, heavily involved in research and development, may XTC not earn meaningful profits for years.

Five funds -- Fidelity Health Care (the oldest, at nearly 10, and the largest, at $624 million in assets), Financial Health Sciences, G.T. Global Health Care, Putnam Health Sciences, and Vanguard Health Care -- are more diversified than the others, but vary in their mixes.

The Putnam and Vanguard health care funds are over 50 percent invested in pharmaceutical stocks.

G.T.'s fund is 24 percent in non-U.S. stocks, concentrated in biotech companies, while Fidelity Medical Delivery is primarily invested in health care facilities.

If you already own one or two well-managed, well-diversified equity funds, you may feel able to accept the short-term volatility associated with a health/biotechnology fund.

But because share price volatility is inevitable, it would be prudent to invest by dollar cost averaging -- that is, a fixed sum at regular intervals -- instead of plunking down a large lump all at once.

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