Capturing investor value from increased healthcare spending by an aging population
Harvest ETFS offers two healthcare ETFS capturing the value of large, innovative U.S. healthcare companies
A recent UN report predicts that people aged 65 years and older will represent 16 per cent of the global population by 2050, up from 10 per cent in 2022. Two ETF products offered by Harvest ETFS aim to capture the income-generating potential of an associated increase in healthcare consumption through largecap U.S. health care companies, combined with a covered call strategy.
The Harvest Healthcare Leaders Income ETF [TSX: HHL] was launched in 2014 and represents an equally weighted portfolio of 20 large-cap US global health care companies, selected for their potential to provide attractive monthly income and long-term growth.
The Harvest Healthcare Leaders Enhanced Income ETF [TSX: HHLE] was launched in 2022 and represents the same portfolio. It aims to deliver enhanced income and growth opportunities by applying modest leverage to an investment in the Harvest Healthcare Leaders Income ETF to capture 1.25 times both the upside and downside.
Paul Macdonald, CFA, chief investment officer at Harvest ETFS, notes that the health care market is characterized by three non-cyclical drivers that offer potential for income.
“As people age, they spend exponentially more on health care and that trend is likely going to continue at least for the medium term,” he says. “Second, as wealth increases in developing nations, spending on health care rises disproportionately. The final foundation of our long-term outlook is technological innovation, leading to the development of new drugs and treatments.”
Harvest healthcare ETFS target large and innovative globally integrated U.S. companies because of their size and because the U.S. health care sector offers plenty of companies to choose from. These include pharmaceutical companies, drug manufacturers, diagnostics companies and medical equipment suppliers. The underlying market caps of the current 20 stocks represented by these ETFS represent a value approximately twice the size of the TSX.
Stocks are selected using the company’s “DNA process”: define the universe of about 3,500 companies, narrow it down to a manageable 85 or 90 companies with a market cap no lower than US$5 billion, then analyze each underlying company.
“The rest is more traditional portfolio construction, including sub-sector diversity,” Macdonald says. “We want to make sure that we’re not overly exposed to any one particular area. One of the hot topics right now is GLP-1 diabetes and obesity drugs, but we would never want to pin 40 per cent of the ETF on a single drug, or even over-represent companies involved in supplying cardiovascular equipment.”
The constituent companies are reviewed quarterly, not only to ensure balance and acceptable exposures, but also to ensure that the financial metrics of these companies exceed those of the larger universe of 85 members.
“Turnover tends to be low,” Macdonald says. “However, we make changes based on strong conviction. For example, we sold Pfizer last summer on some financial metrics that didn’t meet our criteria.”
Harvest ETFS will generally write covered call options on up to 33 per cent of HHL portfolio securities, providing potential for additional monthly income. In Canada, the portion of income generated through covered calls is considered capital gains, not interest income, offering potential for greater portfolio tax efficiency.
Macdonald notes that a successful covered call strategy within the health care arena is driven by intimate knowledge of factors influencing volatility
“The kinds of variables that go into that volatility calculation include known FDA submissions, expected regulatory approval dates, the results of drug trials, or even the results of drug trials from a competitor,” he says. “We use that information around the edges on our options strategy with the objective of capturing premiums in a smart manner.”
Both health-care ETFS are designed for investors looking for regular monthly income. HHL’S most recent distribution was $0.0583 per unit and HHLE paid out$0.0913 per unit.
“If you’re considering these ETFS, I would recommend asking yourself if you want to be invested in the health care sector and whether these types of companies provide the exposure you’re looking to get when you invest in that area,” Macdonald says. “Then ask yourself whether you’re in search of current cash flow or higher income. If it’s cash flow, do you mind giving up on some of the upside of these stocks for that income? HHLE allows you the potential of capturing a little more of that upside.”
While both ETFS look to the long-term investment potential of the U.S. health care sector, he notes that maintaining a more immediate perspective is also important.
“In the shorter term, the sentiment towards the sector, in particular the medical device side of our portfolio, began to really pivot late last year and that’s been validated through corporate earnings,” Macdonald says. “I believe that maintaining both perspectives is serving the portfolio well.”
For more information on Harvest ETFS, visit harvest portfolios.com.