XLV Health Care Select Sector

Though the healthcare sector lost its allure after the wild ride of biotech stocks last month, it is regaining some shine with the pharmaceutical corner of the broader space taking center stage this week (read: Any Survivors from the Biotech ETF Meltdown?).

This is especially true with the ongoing flurry of mergers and acquisitions (M&A) talks in this industry, sending many drug stocks higher. Big pharma companies are looking to reduce their costs through various M&A activities.

Big Pharma Hot Deals in Focus

The Swiss pharmaceutical giant Novartis (NVS) and British drug maker GlaxoSmithKline (GSK) have entered into a multibillion dollar swap deal in which the former would buy the cancer drug business (oncology unit) of the latter for as much as $16 billion and sell its vaccine division, excluding its influenza vaccines, to Glaxo for $7.1 billion in exchange.

Upon completion of the deal, Novartis would be able to generate one-fifth (roughly $10.9 billion) of its annual revenues from the combined cancer drug business which would include Novartis’s Excedrin pain reliever and Maalox antacid, and GlaxoSmithKline’s Aquafresh toothpaste and Nicorette chewing gum.

Meanwhile, Novartis will also sell its animal health division to the U.S. pharmaceutical company Eli Lilly (LLY) for $5.4 billion. Shares of Glaxo rose over 4% in yesterday’s trading while Novartis added 1.3%. LLY shares are up 1.4% (read: A Comprehensive Guide to Pharma ETFs).

Further, the M&A frenzy continued with an offer made by activist investor William Ackman and Valeant Pharmaceuticals (VRX) to acquire Botox-maker Allergan (AGN) for $45.6 billion. Under the terms of the deal, Allergan shareholders will receive $48.30 in cash and 0.83 VRX shares for each share of AGN.

The proposed acquisition, if successful, would be the most powerful in the global eye-care, dermatology and cosmetic drug businesses. AGN shares soared over 15% in yesterday’s trading while VRX climbed about 7.5%.

Moreover, the rumors that the second-largest British drug maker AstraZeneca (AZN) could be a possible takeover target of the U.S. largest drug maker Pfizer (PFE) demonstrates the fact the pharma industry is moving into another period of consolidation. The shares of AZN surged 9% on Monday trading, representing the biggest one-day gain in more than three years following its potential takeover target report in the weekend. Pfizer was up nearly 2.5% in the first two sessions of this week.

ETFs in Focus

The solid trading has been seen in the ETF world as well with pharma ETFs clocking solid gains over the past two days. Funds like SPDR S&P Pharmaceuticals ETF (XPH), iShares U.S. Pharmaceuticals ETF (IHE) and Market Vectors Pharmaceutical ETF (PPH) were up 5.7%, 4.7% and 4%, respectively, over the last two trading sessions. Below, we have highlighted the funds in detail (see: all the Healthcare ETFs here):

XPH - This fund follows the S&P Pharmaceuticals Select Industry Index and has AUM of $822 million. It trades in good volume of more than 132,000 shares a day and charges just 35 bps in fees a year. Holding 35 securities, the product is well spread across each component as each security holds less than 4.4% of total assets. Allergan, Eli Lilly and Pfizer are among the fund’s top 10 holdings.

The fund is also widely diversified across various market cap levels with 45% in large cap, 37% in small caps and the rest in mid caps. The product has gained about 8.50% so far in the year and has a Zacks ETF Rank of 1 or ‘Strong Buy’ rating with Medium risk outlook.

IHE - This ETF tracks the Dow Jones U.S. Select Pharmaceuticals Index and holds 38 securities in its basket. The product is highly concentrated on the top three firms - Johnson & Johnson (JNJ), Pfizer and Merck (MRK) – and collectively make up for 33.54% of total assets. LLY and AGN also occupy the fifth and sixth positions in the basket with nearly 6% share each (read: Solid JNJ Earnings Put Healthcare ETFs in Focus).

IHE is a large cap-centric fund accounting for 74% of the assets. The product has amassed $647 million in its asset base while volume is relatively light at about 34,000 shares a day on average. The fund charges 45 bps in fees per year from its investors. The ETF has gained nearly over 9% year-to-date and has a Zacks ETF Rank of 2 or ‘Buy’ rating with Medium risk outlook.

PPH – This product is less popular and less liquid in the pharma corner of the broad healthcare space with AUM of $315.6 million and average daily volume of less than 59,000 shares. It tracks the Market Vectors US Listed Pharmaceutical 25 Index and charges 35 bps in fees and expenses. In total, the fund holds 26 stocks in its basket that is guilty of concentration on the top 10 holdings at 60.55%.

Some of the in-focus firms – Novartis, Pfizer, GlaxoSmith and Eli Lilly - occupy the top 10 holdings at 9.02%, 7.325%, 4.94% and 4.49%, respectively. Here again, the ETF is tilted toward large cap at 98%. Though PPH currently has a Zacks ETF Rank of 4 or ‘Sell’ rating with Medium risk outlook, it has added more than 12% in the year-to-date time frame.

Bottom Line

Investors should note that these products are clearly outpacing the broad market fund (SPY) and the broad sector fund (XLV) by wide margins (read: 3 Pharma ETFs Beating the Market).

This trend is likely to continue in the coming months as pharma has one of the best ranks for any industry as per the Zacks Industry Rank at the time of writing. All the four Zacks industries that are classified under pharma have Zacks Ranks in the top 36%. Further, huge M&A activities with more to come would continue to boost this corner of the investing world. As such, investors should definitely consider the above-mentioned ETFs in their portfolio.

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ISHARS-US PHARM (IHE): ETF Research Reports
 
MKT VEC-PHARMA (PPH): ETF Research Reports
 
SPDR-SP 500 TR (SPY): ETF Research Reports
 
SPDR-HLTH CR (XLV): ETF Research Reports
 
SPDR-SP PHARMA (XPH): ETF Research Reports
 
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