(PUB) Investing 2016

political uncertainty is likely to create a nice buying opportunity—both for Jean Hynes and the PRIMECAP team buying individual stocks—as well as for investors like you and me looking to ride the long-term health care wave. Now, don’t forget that Health Care had been on a particularly nice run over the past several years—at the end of 2015, it had outpaced Total Stock Market by 9.6% per year over the prior five years. It was only a matter of time until the sector and fund took a breather. And that’s all I think this is—a breather. Take a look at the relative perfor- mance chart to the left, which shows the long-term performance of both Health Care and the MSCI Health Care Index, upon which Vanguard’s health care index fund and ETF are based, versus 500 Index . What you can see (particularly when looking at the active fund) is that despite some periods when the market outperformed, the long-term returns and overwhelming steadiness of Health Care has more than won the day. At some point, Health Care and the health care sector will lag the broad stock market. It’s happened before and will happen again, as the chart shows. In fact, during the first part of the post- Financial Crisis stock market rally, Health Care lagged by a good amount, and some investors began to question their and my commitment to the sector. It’s true that one sector cannot outper- form all the time, or eventually it would become the market. It would be great if we could time those ups and downs, but I don’t think anyone knows how to do that—it’s certainly outside of my circle of competence. And while we shouldn’t expect Health Care’s 20%-a-year pace to persist forever, the long-term tailwinds of demographics, globalization and new product development remain strong. I don’t know how long the lag by health care stocks will last, but I’m sticking with the sector, and in par- ticular with Jean Hynes and her team on Health Care. I suggest you do so as well, and if you have some spare cash available or don’t have at least a 5% position in the fund, that you use this opportunity to add to your holdings. You won’t be disappointed. n

one-quarter of my Growth Portfolio is invested in the sector. As a point of reference, Total Stock Market only has 14% in health care. My other Model Portfolios have a similar emphasis on health care stocks. The stumble out of the gates has some subscribers questioning the prudence of having such an overweight to the sector, so let me explain why I still have convic- tion (and my own dollars) here. I always like to go back to what former Health Care manager Ed Owens used to describe as the three-legged stool that supported the health care sector. It’s the best way to frame the long-term argument for health care that I’ve heard. And, as you’ll see, each leg of the stool is still quite sturdy. The first leg is demographics, which points to increasing demand for health care. As we get older, we tend to spend more on health care than we did when we were younger—and in the U.S., a quarter of a million people turn 65 each month. But this isn’t just a U.S. story; in Japan and Europe, populations are growing older as well. The second leg of the stool is glo- balization. The U.S. outspends the rest of the world on health care by a large margin. While this might mean that we could be more efficient in our spend- ing, it also suggests there is a lot of room for the rest of the world to spend increasing amounts of money on health care. This is particularly true in emerg- ing economies, where the middle class continues to grow. Remember, one of the first things consumers spend on as their wealth increases is better and more health care. The third growth driver for the health care sector is R&D, which leads to new product development. Biotech and medical device companies can be risky investments in their early years, but if their drugs work or their products deliver as expected, then the payoffs can be huge. Plus, if these biotech and medical device companies are success- ful, we could all be living a lot longer, which ties back into the first part of the story about demographics and the ris- ing demand for health care. Two more points here. First, health

Health Care vs. 500 Index 3.50 4.00 Rising line = Health Care or the MSCI Health Care Index outperform 500 Index

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care is a very broad and diverse sector, one which can play both defense and offense. I wouldn’t say health care is immune to recessions, but it tends to be recession-resistant. When times get tough, people keep spending on health care—when you are sick, you visit the doctor. And that means prescriptions and over-the-counter remedies remain in demand. Additionally, the big phar- maceutical companies are large and stable, and have historically held up well when the stock market stumbles; they also pay dividends. One last piece of the puzzle here is top-notch active management. Ed Owens put together a truly remarkable record at Health Care from its May 1984 inception through his retirement at the end of 2012. Former co-manager Jean Hynes has ably taken the reins, and she has not missed a beat, outpac- ing Health Care ETF by 2.5% a year since the end of 2012. The team at PRIMECAP Manage- ment isn’t too shabby at picking stocks in the sector, either. The big question mark hanging over the sector—political action and reform—is only likely to heat up over the next year, but that’s all the more rea- son to partner with an active manager rather than simply decide to invest in the sector through an index fund. I sus- pect we’ll mostly just get rhetorical and political posturing, but if Washington actually does pass or repeal heath care- related legislation (a big “if”), there will be winners and losers—just as there were when the Affordable Care Act was put into law. If anything, the

The Independent Adviser for Vanguard Investors • March 2016 • 7

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