Another Robust Year for Health-Care Funds?

The joy ride of 2000 won't last forever, and volatility is a given. Still, opportunities beckon for long-term investors

Health-care funds sure stole the show in 2000. On the strength of stocks across the industry, the average health-care mutual fund returned an amazing 51.9% over the year. The group's record was unmatched by any other type of fund, beating the second-best performing sector -- energy funds -- by a wide margin.

Of the top 15 mutual funds in 2000, 12 were focused on health care, with their performance far outpacing the technology-heavy Nasdaq in 2000. And that ride may not be over yet. Health-care fund investors expect stellar returns again this year, though it'll be tough to match 2000's pace.

So where should investors interested in health care be looking now? Diversified funds bear the most watching, analysts and fund managers say. These funds invest in stocks of pharmaceutical companies, health-care services, medical devices, drug-distribution companies, and biotechnology. The other segment of the health-care funds sector is biotech. While those funds usually include a smattering of safer pharmaceutical stocks, they consist mainly of riskier biotech ventures.


  The diversified funds are somewhat safer than biotech-only funds, but the biotechs were better performers in 2000. Although investors' enthusiasm for biotech stocks can be expected to wax and wane, downturns in biotech usually are offset by renewed strengths in big-name pharmaceuticals and other mainstream health-care companies. That dynamic gives diversified health-care funds room to breathe during bumpy market conditions.

All the same, it's important to keep in mind that popular sector funds tend to surge for a few years before turning south. The valuations for these trendy funds already may have hit full tilt and will be unsustainable if investors buy them at the tail end of the trend, warns Emily Hall, a fund analyst at "One of the more dangerous things an investor can do is chase performance," she says. "To simply buy because the sector was hot last year is generally a bad way to invest."

Ramy Shaalan, senior mutual-fund analyst at research house Wiesenberger, Thomson Financial, agrees. "This is not for the faint of heart," he says. "Investors need to have a longer time-investment horizon -- a minimum five years." Ross Levin, a financial planner at Accredited Investors, recommends an exchange-traded fund such as Dow Jones U.S. Healthcare (IYH ). The fund is not actively managed and invests only in stocks on the Dow Jones health-care index, which heavily favors pharmaceutical and biotech stocks, but includes managed-care companies and medical devices, among others. There are trading costs, just as when buying or selling a stock, but the investor gets more control over the timing of trades, Levin says.


  For skittish investors, a big fund like Vanguard Health Care (VGHCX ) may provide more comfort. The Vanguard family of funds has found success in a variety of different markets, according to Levin, with its diversified health-care fund recording a gain of 60.6% to make it one of 2000's top performers.

Though sexy, biotech funds are more volatile than their diversified cousins. The Nasdaq Biotech index was up 62.08% for the year, although the Amex Biotech Index did far less well, gaining just 22%. Biotech funds should stay strong, however, as the young industry continues to grow, Shaalan says. "Biotech is still getting momentum. With new discoveries every day, especially within genomics, I think the group going forward will show high volatility, but it has more room for growth."

Some investors fear that biotech funds will be fickle, like the hot information-technology and Internet funds that turned into lemons last year. But Greg Aurand, a senior health-care fund manager for Munder Capital Management, argues that biotech funds differ fundamentally from the fallen angels of those sectors because the industry has proven it can sustain profits. "My thoughts are that maybe they will not be as phenomenal overall next year, but there should be very good returns in health care, and biotech in particular," Aurand says.


  Munder has launched a new fund, Bio(Tech)2, that will focus on biotech only. "It's foolish to say that the fund will do as well as [the sector did in] the past year," Aurand cautions. "Health care had a great year overall, and it would be difficult to duplicate." But if it's any indication for the new fund, a sister fund, Munder Framlington Healthcare A (MFHAX ), had the fifth-best return of all funds, gaining 86.4% in 2000.

No matter how hot health-care funds have been, or what their future may hold, it would be difficult to outdo -- or even match -- the past year's gains, which were driven by unprecedented interest in biotechnology, especially the new field of genomics. Drug stocks in the latter part of 2000 also boosted returns as recession-resistant investments like pharmaceutical companies and HMOs became popular.

Whether to catch a highflying sector like health care while it's still soaring can be a difficult call. "The key to putting money in a health-care fund is that you really need to decide to be in that sector for a while and accept a tremendous amount of volatility in the short term," Levin says. But one thing is for sure: With an increasing number of Americans approaching their senior years, health-care stocks -- and the funds that own them -- are likely to remain in vogue.

By Amy Tsao in New York

Edited by Nancy Ferris

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