Vanguard Health Care ETF: 2 Megatrends In Healthcare (NYSEARCA:VHT)

Overview

The Vanguard Health Care ETF (NYSEARCA:VHT) provides exposure to a stock of companies in the health care sector. As of 11/30/2022, the VHT exchange-traded fund (“ETF”) was invested in 420 different holdings, which includes popular names such as Johnson & Johnson (JNJ) and Pfizer (PFE).

The fund has an expense ratio of 0.10% per annum (2nd cheapest among similar ETFs). Fidelity is the only ETF provider to offer a cheaper expense ratio.

According to Vanguard, the average expense ratio of similar funds is 0.98% per annum.

Cheap expense ratios are a hallmark of Vanguard ETFs, a factor to consider when selecting your ETF provider.

Fund performance

The VHT fund has returned 10.29% per annum since its inception in 2004. The fund tracks its benchmark (Spliced U.S. Investable Market Health Care 25/50 Index) closely and does not trade at a significant premium/discount to NAV.

Overall, the return has been quite strong when compared with the S&P 500 Index (SP500) average return of 11.88% per annum since 1957.

The fund has also performed well in the most recent 10-yr and 5-year periods.

The fund’s performance can be seen below:

Portfolio

The VHT fund is invested in 420 different stocks (versus 394 for the benchmark) with an average P/E ratio of 23.3 and return on equity of 21.3%.

The P/E ratio is not cheap, but it is supported by a strong return on equity.

The fund’s largest sector exposure is Pharmaceuticals at 28%, with the largest single holding being United Health Group at 8.49%.

Also, it is worth nothing that the Vanguard Health Care ETF has a yield of 1.3% and pays a dividend on a quarterly basis.

Now we will look at two megatrends in the healthcare which should support the next leg of growth in the industry.

The first megatrend: demographics

By 2030, 1 in 6 people in the world will be aged 60 years or over, according to the World Health Organization.

The share of population aged 60 years and above is expected to double by 2050 from its current levels, while the number of individuals above 80 years is expected to triple.

With increasing age comes a greater demand for healthcare. An aging population is expected to boost the demand for healthcare over the next few decades.

The change in demographics is a megatrend for the healthcare industry and is a key driver for increased healthcare demand and revenue generation.

According to Citi, the world’s middle class is also growing, largely driven by economic development and rising incomes in Asia.

The expansion of the global middle class and an aging population are two major shifts which provide a supportive backdrop for growth in the health care industry.

The second megatrend: technology

The path for a drug to reach a patient from a research lab is long and costly. According to the California Biomedical Research Association, it takes on average 12 years and US $359 million to develop a new drug.

Additionally, only five in 5,000 drugs that begin preclinical testing make it to human testing, and just one of these five is approved for human usage.

These numbers showcase an inefficient drug discovery process with a lot of money being wasted.

However, the latest advances in Artificial Intelligence [AI] can help streamline and accelerate the drug discovery process.

The potential to reduce time and cost using AI in healthcare is an absolute game-changer for the industry.

For instance, Moderna, Inc. (MRNA) credited the use of artificial intelligence for the quick development of its vaccine during the COVID-19 pandemic.

This efficiency allowed the company to release one of the first COVID-19 vaccines approved by the U.S FDA in record time.

The speed and volume of scientific data being generated daily makes it impossible for an individual to manage, but AI can help scientists gain invaluable insights quickly.

The chart below shows the forecasted increase in R&D spending globally. The healthcare sector has a strong record of innovation, and it seems that the trend will continue.

Risks

Risks to the healthcare sector include government regulation on drug pricing and a reduction in government spending as fiscal budgets recover from the pandemic.

Competition from new entrants such as Amazon (AMZN) in the healthcare space is another risk to monitor. Although it is at a very early stage, Amazon’s role as a disruptor can never be underestimated.

Conclusion

In a difficult economic environment, healthcare is my favorite sector to invest in. Healthcare is the least cyclical of all sectors in my opinion, as it is least tied to economic performance.

Healthcare stocks have shown resilience during turbulent times, for example in 2022, and I expect that trend to continue in 2023 despite the global economic instability.

Demographics and technology also provide a compelling long-term case for portfolio exposure to the healthcare sector via Vanguard Health Care ETF.