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The Spokesman-Review Newspaper
Spokane, Washington  Est. May 19, 1883

Biotech focus may pay

Meg Richards Associated Press

NEW YORK – Health care stocks stood up well during the market’s recent swoon, but if you’re considering adding more of this sector to your mutual fund portfolio, take care to avoid duplicating your existing holdings.

During rough periods, investors often sell riskier issues in favor of more defensive areas such as health care, so it makes sense that it’s the only sector aside from energy and utilities to post a positive gain for 2005; the health care stocks of the Standard & Poor’s 500 are up 0.7 percent, according to the exchange traded fund that tracks the sector. The S&P ETF, or SPDR, that follows consumer staples, another defensive sector, is down 1.6 percent, which is still better than the 4.11 percent slide suffered by the overall market since the year began.

If you use a large-cap fund as the core of your portfolio, chances are you’re already well-exposed to most of the big pharmaceutical names, and perhaps even some of the major health care services stocks, which include hospitals and health maintenance organizations. Rather than shop for a sector index fund that simply replicates the health care universe, and which might mimic the performance of your other large-cap holdings, you might be better served by a portfolio that leans toward small-cap stocks in the fast-growing biotechnology and medical devices industries, said Christopher Davis, fund analyst with Morningstar Inc. But as usual, the potential reward comes with risk.

“If you’re going to be investing in a biotech-focused fund, in order for your investment to pay off, you have to have a strong stomach and a willingness to hang on through bumpy patches,” Davis said. “Otherwise you won’t find your investment very worthwhile.”

There’s bound to be short-term volatility in this area, analysts say, because in addition to all the risks associated with small, speculative companies, there are regulatory hurdles to face. Each time a company hopes to bring a new medicine or treatment to market, it must win approval from the Food and Drug Administration, a lengthy process that presents a whole different layer of risk, and setbacks are generally met with punishing share price declines. But experts say the long-term outlook for the sector remains very strong, partly due to the overwhelming demographic shift associated with the aging of baby boomers.

“You’ve got a large bulge in the population that is getting to an age where they’re going to be demanding more medical care services, and more products to help improve their lives,” said Kenneth McCarthy, chief economist at the Center for Innovative Entrepreneurship, a nonprofit group. “Many of those products will come through biotechnology, genetic engineering and the ability to develop new drugs and procedures for treating illnesses. I think there’s a powerful underlying demand that will continue to grow, and grow rapidly over the next 20 years.”

Of course, the bright idea that turns into a great investment isn’t always something a layperson would recognize. In this sector, knowing which stocks to pick is probably best left to a professional, which makes actively managed mutual funds an attractive choice.

Because there’s so much science involved, it makes sense to look for a fund that is backed by strong research, said Davis, of Morningstar. There are 70 health care sector funds in Morningstar’s database. Sector ETFs, such as the Health Care VIPER from Vanguard and the SPDR, can be had for much less, but these market-weighted indexes will be heavily concentrated in the largest issues. A better idea is to look for a manager “who is really doing something different and distinctive,” Davis said.