Are your clients invested in healthcare?

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Healthcare is vastly underrepresented in Canadian equity markets, comprising just 0.30% of the S&P Composite Index on July 31, 2023.[1] In contrast, healthcare made up 12.79% of the MSCI World Index on the same date.[2] So, Canadian investors have to look outside of our borders to get exposure to a sector with relatively short-term defensive characteristics and long-term growth potential that can add valuable diversification to an equity portfolio.

“Healthcare is a massive global industry that has positive structural long-term tailwinds,” says Paul MacDonald, chief investment officer and portfolio manager at Harvest Portfolios Group. “You’ve got permanent, non-cyclical drivers impacting the long-term growth for the sector.”

Three primary drivers, MacDonald explains, are aging populations, technological innovation, and developing markets. As people age, they spend more on healthcare. Technological innovation is creating rapid advances in areas such as medical devices and both small-molecule and biologic drugs. And healthcare expenditures are rising as wealth increases in developing markets.

Meanwhile, in a macro environment with challenging shorter-term market dynamics, as central banks increase interest rates to rein in high inflation, healthcare may provide partial shelter from the storm. That’s because many of the businesses in the sector often have high margins and low exposure to commodities while producing a “superior good” that’s needed in up and down markets.

Total returns matter more than ever

Cash flow, too, can provide a buffer in the face of a difficult market outlook. In fact, it’s at times like these that cash flow becomes a more important component of total return. This makes a solution such as the Harvest Healthcare Leaders Income ETF attractive to more than just investors seeking exposure to healthcare with a high level of cash flow, MacDonald suggests.

His team chooses 20 equally weighted large-cap healthcare companies for the ETF and then layers on a covered call strategy to enhance cash flow. The options give up a little of the upside of stock performance in return for higher current monthly cash flows. As of July 31, 2023, the ETF’s yield was 8.69%[3].

The companies in the ETF are selected based on a quantitative screen that narrows the universe of global healthcare companies to about 85 U.S.-listed companies offering options.

“We peel back the layers on each one of these companies to build a portfolio of 20, making sure that we’re diversified across each one of the healthcare subsectors,” MacDonald says. “We go through that process quarterly, but turnover tends to be fairly low, just given the front-end analytics we put into picking our 20 companies.”

In the end, investors get access to a sector focused on creating products with real-world applications that change people’s lives. MacDonald points, for example, to exciting developments in robotic-assisted surgery and personalized drugs. He also likes the fact that pharmaceutical firms, in particular, are now pivoting from a pandemic focus back to more normalized business lines and research & development productivity.

At the same time, because of its high yield, the Harvest Healthcare Leaders Income ETF has the potential to generate total returns higher than the broader equity market can deliver right now.

“We provide that monthly, steady cash flow, [and], even if one is not looking specifically for that…given the relative opportunities elsewhere, the covered call strategy can add to that overall total return,” MacDonald says.

¹ www.spglobal.com/spdji/en/indices/equity/sp-tsx-composite-index/#overview (see Factsheet) ² www.msci.com/documents/10199/178e6643-6ae6-47b9-82be-e1fc565ededb ³ https://harvestportfolios.com/etf/hhl/