The market's healthiest sector

Innovation has occurred mostly in biotechnology, and that industry's stocks are on fire. The best-performing exchange-traded fund, or ETF, within the group, up 22% in the past three months, is Biotech HOLDRS (BBH, news, msgs), a basket of 14 names, of which Genentech (DNA, news, msgs) represents nearly 43% of assets.

Roche Holding (RHHBY, news, msgs), which already owns 56% of the maker of such successful cancer drugs as Avastin, Herceptin and Tarceva, has offered to buy up the rest of Genentech's shares for $89 each. The biotech's outside directors are holding out for a higher price, and the market believes they will win -- last week Genentech was trading around $98.

Diversified for good health

Health care is a perpetual political football, and in this decade that has put downward pressure on the sector, as governments have slashed billions in spending to rein in the group's constantly rising prices. Big Pharma, which accounts for 50% of the sector's market capitalization within the S&P 500, is the obvious target.

S&P's Saftlas notes it can make sense to diversify within the group as much as possible; some changes disadvantage one industry while enriching another.

For that matter, health care analysts have noted for years that one of the top names, Johnson & Johnson (JNJ, news, msgs), is itself a diversified portfolio of companies operating in nearly every corner of the sector and united under outstanding management. Pharmaceuticals account for only 40% of its revenue, with the balance spread broadly across medical devices, over-the-counter drugs and consumer products.

• Video: 2 picks in tech and biotech

Over the past year, while the pharmaceutical Spider is ahead 2.7%, Johnson & Johnson has advanced roughly 15%. Meanwhile, iShares Dow Jones U.S. Health Care (IYH, news, msgs) has been little changed, and Vanguard Health Care is down 0.8%.

So this is a case where active management is clearly superior to indexing. Health care investors are better off in the Vanguard mutual fund or Johnson & Johnson stock and not in an ETF.

Aggressive ETF investors do, however, have access to nearly four dozen health care portfolios, including the HealthShares family that targets individual diseases, such as HealthShares Cancer (HHK, news, msgs), as well as leveraged portfolios like Ultra Health Care ProShares (RXL, news, msgs) and leveraged bear market funds like UltraShort Health Care ProShares (RXD, news, msgs). If you are a physician -- or a hypochondriac -- these specialized funds have some appeal.

(Note, though, that this corner of the ETF universe will shrink by 15 funds next month, when XShares Advisors shutters all but four of its HealthShares portfolios. HealthShares Cancer and HealthShares European Drugs will be two of the survivors.)

Overall, health care is benefiting from its traditional status as a defensive sector and from profit growth wrung out of cost savings. A rallying dollar is a potential pothole, but it's more of a niggling doubt at the moment than a powerful negative.

The sector isn't likely to set the world on fire, but it is likely to outperform, and in today's market that's one commodity that's still valuable.

At the time of publication, Tim Middleton did not own or control any funds or stocks mentioned in this column.

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