The healthcare space was mostly out of favor in the first quarter following Democratic Presidential Candidate, Hillary Clinton’s allegation on “price gouging.” The massive decline in Valeant Pharmaceuticals International, Inc.’s (VRX -Analyst Report) shares also had an adverse impact on biotech stocks, eventually dragging the healthcare sector down. Healthcare mutual funds weren’t spared as the category turned out to be the worst performer in the first quarter. Foremost funds from the healthcare space failed to end in positive territory during the period.

Despite this hiccup, investors shouldn’t be demoralized as the long term bodes well for such funds. The healthcare sector is poised to gain from an ageing population both at home and abroad. And with an increase in mergers, and innovative product pipelines and approvals, it’s just a matter of time before the sector bounces back.

Not to forget that biotech stocks have already rebounded in the past few days after being torn apart in the first three months of the year. Banking on this optimism, it will be prudent to invest in healthcare funds that have given solid returns over a long period of time and also boast strong fundamentals. 

Healthcare Losing Ground in Q1

It’s been an awful first quarter for the healthcare sector. Political scrutiny about drug prices took a toll on healthcare stocks. Healthcare Equity Funds nosedived 13.28% during the first quarter, according to Morningstar. Among the worst performing drug makers were Mallinckrodt Public Limited Company ( (MNK -Analyst Report), Horizon Pharma plc (HZNP - Analyst Report) and Endo International plc (ENDP - Analyst Report), whose shares plunged 17.9%, 21.4% and 54%, respectively, in the first quarter.

If you think that was bad, then biotechs had it even worse. The iShares NASDAQ Biotechnology Index plummeted almost 23% in the first quarter. The Valeant Pharmaceuticals disaster was also responsible for the significant underperformance. U.S. lawmakers investigating Valeant’s pricing practices, accusations about accounting irregularities and delay in filing annual reports practically ruined the company. In the first quarter alone, Valeant’s shares plummeted 36.8%.

With the new tax inversion rules the pain seems to have intensified. According to the U.S. Treasury Department and Internal Revenue Service, the rule bars U.S. companies from undertaking inversion transactions if they have done so in the past three years. These inversion deals were a ploy for U.S. drug companies to dodge tax bills by relocating their headquarters abroad.

On the earnings front, things are also looking gloomy. First-quarter earnings from the healthcare sector are anticipated to grow a meager 0.6% from the year-ago level compared with 9.3% growth witnessed in the previous quarter.

Tailwinds are Strong

Even though healthcare witnessed a dismal first quarter, the sector is positioned to grow in the future thanks to an ageing American population. There are about 77 million U.S. baby boomers, which is quite a significant number. An ageing population bodes well for the healthcare sector as they require more medical attention. Along with it, an ageing China also provides long-term opportunities for both U.S. pharmaceutical and medical technology companies.

The need to trim costs and tap growth opportunities are driving healthcare firms into mergers and acquisitions (M&A). Additionally, the Fed’s dovish outlook to proceed cautiously on hiking rates is also expected to boost M&A deals.

Also, the first FDA-approved biosimilar, Zarxio, hit the market last year. Biotech companies are now vying to enter this high revenue generating space. Several other products such as Imlygic, Ibrance, Strensiq, Genvoya and, PCSK9 inhibitors, Praluent and Repatha also got approved. This in turn is expected to help companies from the healthcare space to generate steady revenues. Thanks to the mandated healthcare coverage in the U.S., more Americans are seeking treatment, which is also a net positive for healthcare firms.

5 Healthcare Mutual Funds to Invest In

As discussed above, these tailwinds may collectively act as growth facilitators and help the healthcare sector overcome the drubbing it took in the first quarter. In case of inversion rules, healthcare companies will continue to seek creative ways to relocate their tax residence to avoid paying the lofty taxes at home, as per the Treasury Secretary Jacob J. Lew.

Since the long run holds good for the healthcare sector, it will be wise to buy mutual funds associated with the sector. These funds have yielded positive returns for a long time despite being in the red in the first quarter. Moreover, these funds are fundamentally solid, which will eventually help them gain in the future as well.

We have selected five healthcare mutual funds that have impressive 3-year and 5-year annualized returns and carry a Zacks Mutual Fund Rank #1 (Strong Buy) or #2 (Buy). These funds also possess a relatively low expense ratio and have minimum initial investment within $5000.

T. Rowe Price Health Sciences (PRHSX - MF report) invests a large portion of its assets in companies engaged in the development and distribution of health care products. PRHSX’s 3-year and 5-year annualized returns are 19.7% and 21.1%, respectively. Annual expense ratio of 0.76% is lower than the category average of 1.35%. PRHSX has a Zacks Mutual Fund Rank #1.

Fidelity Select Health Care (FSPHX - MF report) invests a major portion of its assets in companies involved in the manufacture and sale of products used in connection with health care. FSPHX’s 3-year and 5-year annualized returns are 19.2% and 18.8%, respectively. Annual expense ratio of 0.74% is lower than the category average of 1.35%. FSPHX has a Zacks Mutual Fund Rank #2.

Hartford Healthcare A (HGHAX - MF report) invests the majority of its assets in the equity securities of health care-related companies worldwide. HGHAX’s 3-year and 5-year annualized returns are 17.3% and 17.7%, respectively. Annual expense ratio of 1.28% is lower than the category average of 1.35%. HGHAX has a Zacks Mutual Fund Rank #2.

Live Oak Health Sciences (LOGSX - MF report) invests a large portion of its assets in equity securities of health sciences companies. LOGSX’s 3-year and 5-year annualized returns are 16.1% and 15.7%, respectively. Annual expense ratio of 1.08% is lower than the category average of 1.35%. LOGSX has a Zacks Mutual Fund Rank #2.

Fidelity Select Biotechnology (FBIOX - MF report) invests the majority of its assets in companies engaged in the manufacture and distribution of various biotechnological products. FBIOX’s 3-year and 5-year annualized returns are 16.1% and 23.7%, respectively. Annual expense ratio of 0.74% is lower than the category average of 1.35%. FBIOX has a Zacks Mutual Fund Rank #2.