A Member of Pat McKeough’s Inner Circle recently asked for his advice on Invesco S&P SmallCap Health Care ETF, a fund that focuses on small-cap U.S. healthcare firms.
Pat likes the low MER, but finds the “capped” aspect of the fund’s management to be a major negative as it forces the fund to sell off its best-performing companies every quarter.
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The Invesco S&P SmallCap Health Care ETF (Symbol PSCH on Nasdaq; www.invesco.com) invests in smaller U.S. firms involved in the health-care industry. They operate in areas such as biotechnology, pharmaceuticals, medical technology, medical supplies, and medical facilities.
In 2018, the ETF changed its name from the PowerShares S&P SmallCap Health Care ETF, after Invesco bought the ETF business of Guggenheim Investments.
The fund tracks the S&P SmallCap 600 Capped Healthcare Index. The ETF, however, holds just 82 stocks. Among those firms, its top holdings are Ensign Group, (5.1%), AMN Healthcare Services (4.1%), Cytokinetics Inc. (3.9%), Merit Medical Systems (3.9%), Prestige Consumer Healthcare Inc. (3.2%), CONMED (2.9%), Select Medical Holdings (2.9%), Integer Holdings Corp. (2.4%), and Glaukos Corp. (2.3%).
The industry exposure for investors is Health Care Providers & Services, 28.1%; Health Care Equipment & Supplies, 25.8%; Biotechnology, 22.9%; Pharmaceuticals, 16.4%; Health Care Technology, 4.8%; and Life Sciences Tools & Services, 2.2%.
The fund started up in April 2010 and has a low MER of 0.29%.
Inner Circle: This strategy doesn’t look like a winner for Invesco S&P SmallCap Health Care ETF
However, it operates in a highly volatile market segment, and the “capped” aspect of its mandate introduces a filtering mechanism: the fund doesn’t let any one stock holding rise above 22.5%. The ETF rebalances its portfolio every quarter, and if a stock has risen above that 22.5% threshold, it sells enough shares to bring it below the cap. It then allocates the proceeds to other holdings.
As well, the aggregate weight of securities with more than a 4.5% allocation is capped at 45% of the total weight of the portfolio.
While 22.5% is a high percentage threshold for any stock to reach, it could—along with the 4.5%/45% cap—force the fund to arbitrarily sell off shares of some of its biggest winners. And in a volatile market category like this, an ETF needs some big winners to overcome the unavoidable huge losses.
Recommendation in Pat’s Inner Circle: The Invesco S&P SmallCap Health Care ETF is not recommended.