Why Health Reforms Won't Kill Health Stocks

Fidelity manager: Undervalued healthcare sector could hold bargains, and still has potential for growth.

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Those demographic factors do not represent a growth boom but a "slow tailwind that will help boost demand." Stable demand has been the main appeal of drugmaker stocks, a core holding for investors seeking defensive stocks to balance their portfolios. But while the big firms are relatively recession-proof, they have also been dull market performers because of their inability to develop new breakthrough drugs like Viagra or Lipitor, Pfizer's $100 billion wonder drug whose patent expired in 2011.

Yoon's Fidelity Select owns some of the big pharmaceutical companies as a way to limit downside risks, but less of them than health index funds that fully include their high market capitalizations. Yoon's Fidelity Select has shifted investments in ways that anticipated the impact of healthcare reforms on major players. It has only one large-scale insurer, Cigna, listed in its top holdings.

"I like [healthcare information technology] stocks and biotech and am avoiding those stocks that have highest exposure to government reimbursement risks," says Yoon.

He invests selectively in early-stage biotechs as a way to boost growth, including a handful of long shots he hopes can provide outsized returns. His fund also lists large positions in established biotechs Gilead Sciences and Amgen. For other sources of growth, the fund looks for direct investments in emerging markets and a wide range of healthcare equipment, which covers testing and technology tools, a sector that has grown steadily in recent years.

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The multi-level strategy has helped the fund outperform its benchmarks and most other funds in its category by solid margins over the past three years, with a three-year annualized return of 16.89 percent that's ahead of both its benchmark and the S&P 500. Its five-year annualized return of 9.28 percent, going back to 2007, is well ahead of the S&P's 3.94 percent gain.

"Healthcare is a place where active management really makes sense," says Yoon. "There are so many stories for each of the companies out there, and they are all different. By understanding and researching them, you can provide the alpha that makes the cost of active management worth it."