Defensive investing: Utility and healthcare sector ETFs

Healthcare sector

The healthcare sector encompasses companies that are involved in medical care, from hospitals, pharmaceutical companies, and medical device manufacturers. These companies tend to hold up better during recessions due to the inelastic demand for their products and services. 

While consumers might cut their discretionary spending (thus hurting retail and technology companies), healthcare companies tend to have evergreen demand. As a sector, healthcare stocks have historically delivered a lower correlation to the broad market and lower volatility. 

As seen below, the healthcare sector of the S&P 500 has historically outperformed the broader index, with lower max drawdowns during numerous bear markets such as 2001, 2002, 2008, 2018, and 2022. 

Investors who wish to "tilt" their portfolios to the healthcare sector have two main options, one from Vanguard and one from State Street:

1. The Health Care Select Sector SPDR Fund (XLV) tracks a market-cap weighted index of 64 healthcare stocks in the S&P 500. It's dominated by large-caps and costs an expense ratio of 0.10%.
2. The Vanguard Health Care ETF (VHT) tracks a market-cap weighted index of 399 healthcare stocks from the broad U.S. market. It has more of an allocation to small and mid-caps and costs an expense ratio of 0.04%. 

Utilities sector

Historically, the U.S. utilities sector has displayed a fairly consistent low correlation with the broader market (0.43 as of November 24th, 2022). That, coupled with its positive expected returns (largely due to consistent and growing dividends) makes utilities an attractive long-term hold. 

As with healthcare stocks, utilities benefit from evergreen demand. When times are rough, people might cut discretionary spending, but the gas, electric, and hydro bills will still be paid. Demand is therefore less volatile, which translates to more consistent earnings and thus stable share prices. 

As seen below, the utilities sector of the S&P 500 has also historically outperformed the broader index, with lower max drawdowns during numerous bear markets such as 2000, 2008, 2018, and 2022.

As with healthcare stocks, investors who wish to "tilt" their portfolios to the utilities sector have two main options, again from Vanguard and State Street:

1. The Utilities Select Sector SPDR Fund (XLU) tracks a market-cap weighted index of 30 utilities stocks in the S&P 500. It's dominated by large-caps and costs an expense ratio of 0.10%.
2. The Vanguard Utilities ETF (VPU) tracks a market-cap weighted index of 65 utilities stocks from the broad U.S. market. It has more of an allocation to small and mid-caps and costs an expense ratio of 0.04%.

Vanguard or State Street?

The SPDR funds are more concentrated and focused on large-cap stocks found in the S&P 500. If you're a fan of the committee's selection process and want a concentrated play, the SPDR funds are better.

If you're looking for lower expense ratios and a "buy the haystack" mentality, the Vanguard ETFs might be more appealing. They're still market-cap weighted, so their largest holdings will have the most effect. 

Personally? I think the ETFs of both providers make for excellent tax-loss harvesting pairs, given that they perform similarly yet track different indexes. 

Please note this article is for information purposes only and does not constitute investment advice.