Long thought to be an industry that could be banked on for stability by defensive investors during periods of turmoil, the healthcare industry should now be carefully navigated.

Two sectors within the industry that are worth noting right now are healthcare providers and biotech. These two sectors have experienced drastically different fates so far in 2008, and the trend might be expected to continue. Year-to-date, the iShares Dow Jones Healthcare Provider Fund (IHF) has choked on a loss of 46.4%. This performance is worse than that of the S&P 500 which is down 39.2% so far this year. It is far worse than the performance turned in by the Biotech HOLDRs Trust (BBH).

With a year-to-date return of 1.8%, BBH has proven to be unshakable. Of the 812 ETFs tracked by Morningstar, only 57 are in positive territory in 2008. BBH is the only non-inverse ETF of the bunch that tracks equities. Even in the past 30 days, as the S&P 500 has shed 26.2%, BBH is only down 10.6% while IHF has fallen 25.3%.

As far as IHF goes, we knew there were problems very early on in the year. Between March and April, three of the five largest insurers painted a grim picture for the year as they reported their fourth-quarter results. WellPoint (WLP) cut its full-year outlook due to higher-than-expected medical costs. Humana (HUM) did the same as it used the performance of its Medicare Part D plan as a scapegoat. UnitedHealth Group (UNH) pointed to unusually high influenza costs and a decline in membership for its risk-based commercial markets products as contributing factors to a downward revision in its full-year outlook.

The recent third-quarter results that were reported by these three companies did nothing to instill confidence in investors. WellPoint checked in with a 1.8% decrease in revenue versus a year ago as its benefit expense ratio was adversely impacted by higher medical costs and membership mix changes. The healthcare provider also cut its forecast for 2009. Higher operating costs drove down UnitedHealth’s Q3 as EPS decreased 21.1% on a year-over-year basis. For ’09 the company offered up a cautious outlook based upon the expectation of lower membership and flat earnings. Humana is expected to post EPS of $1.47 versus adjusted EPS of $1.53 in its year-ago quarter.

The picture has been much rosier in biotech. Names such as Genentech (DNA), Amgen (AMGN), Celgene (CELG) and Biogen (BIIB) have all reported robust third-quarter results. I spoke to Hamed Khorsand a biotech analyst for BWS Financial for one of my recent articles for TheStreet.com. Relative to other sectors, Khorsand was fairly optimistic on the future outlook for biotech. He noted that valuations across the board in biotech have become very compelling. His top three picks  in the space right now are Gilead Sciences (GILD), Biogen and Cephalon (CEPH). Gilead and Biogen account for approximately one quarter of the weight of BBH. Cephalon is not currently a holding of this ETF.

For my article, I also interviewed Philip Yockey, president and chief investment officer of Tactical Analytics, an independent private research company. His ratings system incorporates both fundamental and technical metrics. Yockey noted that BBH is not as cheap as the iShares Nasdaq Biotech Fund (IBB). He however has held a negative sentiment towards IBB since it broke below $80 per share.

IBB offers investors a portfolio that is more diverse than BBH. IBB spreads out its weight across 147 holdings. BBH only has 12 holdings. However in this instance, I like the narrow focus of BBH given the strong results that are being turned in by the fund’s largest holdings. The one soft spot in this ETF right now is Affymetrix (AFFX). On Friday, the company reported a rough Q3 that resulted in a net loss. Affymetrix has seen its stock price cut in half over the course of the past month and was hit with a downgrade by Deutsche Securities following its earnings release. The company is one fifth of the weight of BBH.

One other biotech ETF to look at here is the SPDR S&P 500 Biotech ETF (XBI). It is a balanced fund that has 22 holdings. It is only down 15.8% this year.  

Given their past trends and recent earnings results, IHF and BBH appear to be headed in different directions. Another looming problem for the insurers is that it is unclear if there is even an outcome from the November elections where they would not be adversely impacted from future legislative policies.

Investors looking to get defensive might want to take a more focused approach when looking at healthcare given the differing outlooks for the provider and biotech sectors. As a paired trade, I would consider taking a long position in BBH and a short position in IHF right now.

Billy Fisher
Oxbury Research