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An Excellent Choice for Broad Exposure to Healthcare

Gold-rated Vanguard Health Care benefits from an experienced manager.

The following is our latest Fund Analyst Report for Vanguard Health Care Inv
(VGHCX). Morningstar Premium Members have access to full analyst reports such as this for more than 1,000 of the largest and best mutual funds. Not a Premium Member? Gain full access to our analyst reports and advanced tools immediately when you try Morningstar Premium free for 14 days. 

Vanguard Health Care’s capable manager, deep industry expertise, and sensible approach warrant a Morningstar Analyst Rating of Gold.

Few rivals can match this strategy’s tenured leadership and ample research support. Wellington veteran Jean Hynes has led this fund since longtime manager Ed Owens retired in January 2013. She has been on Wellington’s healthcare team since 1991 and comanaged with Owens since 2008. An experienced 13-member team backs Hynes. She has built the team gradually to keep pace with its growing global opportunity set, adding three analysts in the past two years. Longtime analysts Ann Gallo and Robert Deresiewicz anchor the team. Along with Hynes, they comanage Gold-rated Hartford Healthcare (HGHAX), an all-cap version of this strategy.

This strategy’s bottom-up approach capitalizes on the team’s expertise and avoids one-size-fits-all thinking. They look for innovative healthcare companies with differentiated products or services and attractive valuations relative to their growth prospects. Within each sub-industry, though, the managers give significant autonomy to analysts and let them analyze companies the way they see fit based on the particularities of their areas. For biotechnology and pharma stocks, for instance, they tend to focus on the usefulness and probability of success of drugs in development; for healthcare services, they emphasize quality of management and execution.

The portfolio, which is more geographically diversified than the typical healthcare Morningstar Category peer, has shifted further abroad since mid-2017. As of September 2019, the fund had 31% in non-U.S. stocks, compared with the typical peer’s 14%. Hynes thinks stocks like Swiss drugmaker Novartis (NOVN) and UK-based AstraZeneca (AZN) are well positioned to benefit from increasing global healthcare demand. This strategy’s low turnover--half that of the typical peer over the trailing five years--gives such long-term bets time to play out.

Associate analyst Nick Watson contributed to this report.

Process | Above Average 
A proven, repeatable investment approach earns this strategy an Above Average Process rating.

Hynes and her 13-member team employ a bottom-up, long-term-oriented, and valuation-aware approach. They look for innovative companies with differentiated products or services and attractive valuations relative to their growth prospects. The process capitalizes on the team’s deep industry expertise and avoids one-size-fits-all thinking. For biotechnology and pharma stocks, for instance, it focuses on the usefulness of drugs in development and their probability of success; for healthcare services, it emphasizes quality of management and execution. Turnover typically stays below 20%, compared with its typical peer’s 40% over the trailing five years through 2019.

The management can invest across healthcare subsectors and geographies, sometimes deviating from the MSCI ACWI Health Care Index or the category norm. The strategy has often devoted 20% to 30% of its assets to overseas stocks. The size of the strategy constrains its ability to venture too far down the market-cap scale. Yet, that has not impaired its success over time as the team has generally favored mid-caps and large caps even when its asset base was smaller.

This healthcare offering is diversified across geographies and industries. As of September 2019, the fund had 31% of assets in non-U.S. stocks, compared with 14% for the typical healthcare category peer. The fund has shifted further abroad since mid-2017. Manager Hynes says the improving fundamentals of individual stocks has motivated the shift as opposed to a change in macro outlook. She likes Swiss drugmaker Novartis, which has been more focused on innovation since its management change in 2018, and UK-based AstraZeneca, which she thinks is well positioned for growth in China. Both were top-10 positions in the most recent portfolio.

Hynes is willing to pass on some of the industry’s largest players and invests in more mid-cap stocks than the MSCI ACWI Health Care Index, both of which contribute to the fund’s smaller average market cap than the index. For instance, she doesn’t own Johnson & Johnson JNJ, a major index constituent. She likes its pharma business but thinks its medical technology innovations haven’t kept pace. Some of her biggest mid-cap bets include pharmaceutical company Mylan (MYL), hospital and service provider Universal Health Services (UHS), and biotech stocks Incyte (INCY) and Alnylam (ALNY). The most recent portfolio’s 15.2% biotech stake was higher than the index’s 8.4%, but lower than sibling Hartford Healthcare’s (HGHAX) 25.7%, which is an all-cap version of this strategy.

People | High 
This team’s stability and depth warrant a High People rating.

Hynes has led this fund since succeeding longtime manager Ed Owens in January 2013. Hynes had comanaged with Owens since May 2008 and has been on Wellington Management's healthcare team since 1991. She invests more than $1 million in this fund and its all-cap sibling Hartford Healthcare.

An experienced 13-member team of 10 analysts and three research associates support Hynes, who covers pharmaceutical stocks. Longtime analysts Ann Gallo, who covers healthcare services and drug stores, and Robert Deresiewicz, who focuses on biotech, have been on the team since 1998 and 2000, respectively. Hynes and Gallo have comanaged Gold-rated Hartford Healthcare since its inception in 2000, and Deresiewicz since 2004. The team has expanded gradually to keep up with its growing global investment universe. It added three analysts in 2013: Rebecca Sykes (medical device companies); Catherine Arnold (pharmaceuticals); and David Khtikian (small- and mid-cap healthcare services). Those hires offset the 2017 retirement of veteran Kirk Mayer. The team also hired an analyst and promoted two research associates in 2018, and added two new analysts in 2019: Irina Margine, a microbiology Ph.D., and Liz Shortsleeve, a former high-yield credit analyst who focuses on specialty pharmaceutical firms.

Parent | High 
The Vanguard Group entered a new era in early 2019 with the passing of its founder and conscience, John C. Bogle. Unlike its mid-1970s origins, when outflows were the norm and its survival was in question, Vanguard now wears the crown as the world's biggest retail asset manager. More than 90% of its USD 5.6 trillion in global assets under management, as of June 2019, are in the United States; but the firm has designs to grow its non-U.S. business, especially in the United Kingdom, Australia, Canada, Japan, China, and Mexico.

Vanguard gained its stature by following Bogle’s playbook: pairing relatively predictable strategies, both passive and active, with minimal costs. That’s enriched Vanguard’s investors, and those outside its flock who have benefited from industrywide fee compression. While Vanguard’s passive business now faces stiff price competition from its biggest rivals, inflows into its U.S. strategies still dominate.

Not content, Vanguard aims to transform investment advice, too. In May 2015, it launched Personal Advisor Services, a burgeoning discretionary asset-management business that pairs automation and human advice; and in September 2019 it disclosed plans to launch a digital-only counterpart. Vanguard’s industry leadership readily merits a High Parent rating, but the firm must stay on its guard to prioritize investor interests over merely expanding its kingdom.

Performance 
This strategy has been a good long-term performer under manager Hynes, though its recent results haven’t been as strong.

From Hynes’ start as lead manager in 2013 through January 2020, the strategy’s 15.5% return topped the MSCI ACWI Health Care Index’s 12.8% gain. Hynes’ tenure got off to a fast start, with impressive stock-picking in pharmaceuticals contributing to index-beating gains between 2013 and 2015. In 2016, not holding outperformer Johnson & Johnson (JNJ), combined with a handful of misfires in biotech, led to a larger loss than the index.

Since then, performance has kept pace with the index. Stock selection has been the main driver of performance, though having less exposure to equipment and supplies stocks hurt the fund over the trailing three years through January 2020. Over Hynes’ tenure, the fund lags the typical healthcare Morningstar Category peer on an absolute basis but tops it on a risk-adjusted basis. The category includes specialty biotech funds that posted outsize gains in 2013 and 2019, for instance, but have been much more volatile than this fund.

Distributions are worth watching. The fund has been in redemptions over each of the past four calendar years, and its annual capital gain distribution averaged 6.7% of the fund’s net asset value over that time period.

Price 
It’s critical to evaluate expenses, as they come directly out of returns. The share class on this report levies a fee that ranks in its Morningstar category’s cheapest quintile. Based on our assessment of the fund’s People, Process and Parent pillars in the context of these fees, we think this share class will be able to deliver positive alpha relative to the category benchmark index, explaining its Morningstar Analyst Rating of Gold.

Dan Culloton has a position in the following securities mentioned above: VGHCX. Find out about Morningstar’s editorial policies.