Text size: 

A A A
 

Fund managers see opportunity for healthy returns

May 24, 2013

A roundup of the latest Vanguard mutual fund reports

PDF Note: To view the reports mentioned in this article, you'll need to have Adobe Reader installed on your computer.

Investments in a specific sector or market niche can be much more volatile than the broader financial markets, and the health care sector has been vulnerable and volatile in recent years. Still, since the financial crisis recovery began, health care stocks have generated double-digit returns while slightly lagging the broad U.S. stock market.

Investors in the health care sector have had no shortage of challenges to contend with. Uncertainty surrounding health care reform legislation has, at times, limited returns over the past few years, and the pharmaceutical industry has dealt with expiring patents on several blockbuster drugs, making them vulnerable to generic competition. Also, the U.S. Food and Drug Administration (FDA) has tightened regulations, slowing the approval process for new drugs and leaving some pharmaceutical companies with little in the product pipeline.

Over the last few months, however, some of the short-term trends that have restrained health care stocks have begun to shift. The FDA has been approving more drugs in recent months, and the pipeline for new medicines is showing renewed life.

While acknowledging the risks that go along with investing in a narrow segment of the market, several of the outside investment firms that manage Vanguard funds are encouraged by the long-term trends for health care.

In the most recently published Vanguard fund reports, which cover the six months ended March 31, 2013, PRIMECAP Management Company, manager of several Vanguard funds—PRIMECAP, PRIMECAP Core, and Capital Opportunity—discussed its reasons for optimism about health care:

"Global demographic trends and ongoing innovation should sustain the sector's growth over the foreseeable future. Aging populations worldwide, along with rising standards of living in emerging markets, should lead to greater demand for health-related products. As the elderly cohort increases, spending will grow, because older people typically consume three times as many health care resources as the general population. In addition, as household wealth increases in developing nations, their populations' willingness and ability to spend on health care should rise as well."

Baillie Gifford Overseas Ltd., co-manager of Vanguard Growth Equity and Vanguard Global Equity Funds, also offered a positive take on the health care sector's prospects:

"Although major pharmaceutical stocks have certainly suffered from regulatory pressure, that becomes counterproductive if innovation is stifled. In that context, we believe that the government would like the FDA to take more risk to facilitate the discovery of novel drugs, and that such a shift is already being seen in a rising number of new drug licenses. This is not to say that health care is suddenly a high-growth industry, but it might well be getting better, and change for the better is usually a powerful driver of share price."

Focus on liquidity

Bonds, which can be useful as a way to diversify a portfolio or provide an income stream, have performed strongly over the past three decades with steady price appreciation. But yields, while still low, have risen from their rock-bottom levels. Because bond prices and yields move in opposite directions, bond returns have been limited in recent months.

Another concern for the bond market—specifically the corporate sector—is liquidity, which refers to how readily an asset can be bought or sold. Vanguard Wellesley® Income Fund, which is made up of about 60% bonds and 40% stocks, concentrates most of its bond holdings in the corporate sector. Wellington Management Company, LLP, manager of the Wellesley Income Fund, discussed the liquidity issue in its letter to shareholders:

"Liquidity in the corporate bond sector, in which the fund invests the majority of its fixed income assets, has improved somewhat but remains poor . . . Pending regulations and increased capital requirements are expected to reduce market liquidity and increase transaction costs over time."

Ultimately, however, Wellington said it remains optimistic about corporate bonds. "We still view the U.S. corporate bond sector favorably, as it has weathered the current economic and business cycles relatively well."

A place for index and active investing

Vanguard, an index proponent and pioneer, also offers a full lineup of actively managed funds. Vanguard Chairman and CEO Bill McNabb is sometimes asked whether this is a contradiction: embracing both index and active investing. He addressed the issue in the conclusion to several letters to shareholders:

"To understand how active funds fit into our philosophy, consider for a moment why indexing has proved its mettle: It's a generally low-cost, tax-efficient way to build a diversified portfolio that lets you keep more of your fund's returns. Because index funds seek to track the overall market or a segment of it, they typically cost much less to run than funds that are actively managed in an effort to outperform the market. And the less you pay for a fund, the more of its returns come back to you.

"The same principle—low cost—drives our approach to active funds. The other essential ingredient is talent. Some wonder how we can afford to hire top active managers when we place such importance on keeping investing costs low. The answer lies in five key characteristics of Vanguard's structure and culture—our mutual ownership, our large scale, performance incentives aligned with investors' interests, a long-term perspective, and a rigorous oversight process, which I lead." (You can read more about our approach in The case for Vanguard active management: Solving the low-cost/top-talent paradox?)

Other recently published reports:

Vanguard Capital Value Fund

Vanguard Equity Income Fund

Vanguard Growth and Income Fund

Vanguard Morgan™ Growth Fund

Vanguard Strategic Equity Fund

Vanguard Strategic Small-Cap Equity Fund

Vanguard U.S. Value Fund

Notes:

  • All investments, including a portfolio's current and future holdings, are subject to risk.
  • Diversification does not ensure a profit or protect against a loss in a declining market.
  • Funds that concentrate on a relatively narrow market sector face the risk of higher share-price volatility.
  • Bonds and bond funds are subject to the risk that an issuer will fail to make payments on time and that bond prices will decline because of rising interest rates or negative perceptions of an issuer's ability to make payments.
  • Past performance is no guarantee of future results.
PrintComment | E‑mail | Share | Subscribe