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Pharma ETFs Outlook — Drug Pricing Issues Remain in Focus

The pharma sector remains in the limelight thanks to the drug pricing controversy. The sector has been under a lot of pressure since Sep 2015 when Democratic presidential frontrunner Hillary Clinton’s “price gouging” tweet triggered a slide in healthcare stocks.
 
While there have always been concerns regarding the pricing and affordability of prescription drugs, the issue is back in focus following a 5000% price hike implemented by Turing Pharmaceuticals for Daraprim (pyrimethamine) that was approved by the FDA way back in 1953.
 
Other companies like Valeant are also under review for significantly hiking the prices of acquired drugs. According to the Oct 2015 Kaiser Health Tracking poll, affordability of prescription drugs remains at the top of the public’s priority list for the President and Congress – focus should be on ensuring the affordability of high-cost drugs to people who need them and taking steps to lower prescription drug prices.
 
So drug companies may find it a bit difficult to justify their high prices by citing the years and funds that go into bringing new treatments to market and the need to invest in R&D to bring additional treatments to market.
 
In addition to the impact of the increasing political and media focus on high price tags for new drugs, other factors like oil prices, global terrorism and China are also weighing on the performance of the sector. (Read: 7 Best Stocks & ETFs of 7-Year Bull Run)
 
M&As to Continue?
 
With the major price correction that has resulted in reasonable valuations, we could see several merger and acquisition (M&As) agreements being announced as the year progresses. Meanwhile, small bolt-on acquisitions will continue.
 
However, with the Treasury Department coming out with new guidelines, tax inversion deals are once again losing popularity. The termination of the Pfizer-Allergan merger agreement will act as a deterrent for deals of a similar nature.
 
In-licensing activities and collaborations for the development of pipeline candidates have also increased significantly. Several pharma companies are focusing on in-licensing mid-to-late stage pipeline candidates that look promising, instead of developing a product from scratch, which involves a lot of funds and time. Small biotech companies are open to such deals -- most of them find it challenging to raise cash, thereby making it difficult to survive and continue with the development of promising pipeline candidates. Therefore, it makes sense to seek deals with pharma companies sitting on huge piles of cash. (Read: Trump Healthcare Reforms: Will ETFs Gain or Suffer?)
 
Therapeutic areas attracting a lot of interest include central nervous system disorders, hepatitis C virus (HCV) and immunology/inflammation. Another highly lucrative area is immuno-oncology. Major players in this field include Bristol-Myers, AstraZeneca, Merck and Roche.
 
Another trend being witnessed is the divestment of non-core business segments. Companies like Pfizer, UCB, Novartis, Glaxo and AstraZeneca have all been a part of this trend. The monetization of non-core assets allows these companies to focus on their areas of expertise.
 
Restructuring activities are also gaining momentum as large pharma companies are looking to cut costs and streamline their operations. Most of these companies are re-evaluating their pipelines and discontinuing programs which do not have a favorable risk-benefit profile. Swapping of businesses is another activity that could pick pace in 2016.
 
New Products Should Gain Traction
 
Highly-awaited new products that gained approval last year should contribute significantly to revenues. While 45 new molecular entities (NMEs) and Biologics License Applications (BLAs) were approved by the FDA last year, so far in 2016, the FDA has approved 5 NMEs and BLAs.
 
Biosimilars are also a focus area. Pfizer’s acquisition of Hospira gives it a strong position in the biosimilars market. Companies like Merck and Novartis are involved in the development of biosimilars as well – in fact, Novartis’ Sandoz was the first company to launch a biosimilar in the U.S. 
 
Pharma ETFs in Focus
 
Highlighted below are some pharma ETFs - ETFs present a low-cost and convenient way to get a diversified exposure to the sector.
 
Powershares Dynamic Pharmaceuticals ETF (PJP)
 
PJP, launched in Jun 2005 by Invesco PowerShares, tracks the Dynamic Pharmaceuticals Intellidex Index. The fund covers health care stocks. The top 3 holdings include Merck & Co. Inc. (5.29%), Gilead Sciences Inc. (5.28%) and Pfizer Inc. (5.21%). The total assets of the fund as of Apr 8, 2016 were $1,177.6 million representing 23 holdings. The fund’s expense ratio is 0.56% while dividend yield is 4.31%. The trading volume is roughly 142,657 shares per day.
 
SPDR S&P Pharmaceuticals ETF (XPH)
 
XPH, launched in Jun 2006, tracks the S&P Pharmaceuticals Select Industry Index. This ETF primarily covers pharma stocks (99.9%) with the top 3 holdings being Relypsa, Inc. (7.11%), Pacira Pharmaceuticals, Inc. (5.02%), and Zoetis Inc. (4.87%).
 
Total assets as of Apr 8, 2016 were $563.9 million representing 38 holdings. The fund’s expense ratio is 0.35% and dividend yield is 0.60%. The trading volume is roughly 117,304 shares per day.
 
iShares U.S. Pharmaceuticals (IHE)
 
IHE, launched in May 2006, seeks investment results that correspond generally to the price and yield performance of the Dow Jones U.S. Select Pharmaceuticals Index. The fund mainly consists of pharma companies (86.6%). Biotech companies account for about 13.3% of the fund.
 
The top 3 holdings of this fund are Johnson & Johnson (9.52%), Pfizer (8.53%) and Merck & Co. Inc. (7.64%). The total assets of the fund as of Apr 11, 2016 were $659 million representing 42 holdings. The fund’s expense ratio is 0.45% with the dividend yield being 1.06%. The trading volume is roughly 48,947 shares per day.
 
Market Vectors Pharmaceutical (PPH)
 
PPH was launched in Dec 2011 and tracks the Market Vectors U.S. Listed Pharmaceutical 25 Index. While the expense ratio is 0.35%, dividend yield is 2.31%. The trading volume is roughly 32,886 shares per day.
 
Conclusion
 
While negative currency impact and pricing pressure remain headwinds, cost-cutting, downsizing and new products should support growth. Increased pipeline visibility and appropriate utilization of cash should increase confidence in the sector.
 
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PWRSH-DYN PHARM (PJP): ETF Research Reports
 
SPDR-SP PHARMA (XPH): ETF Research Reports
 
ISHARS-US PHARM (IHE): ETF Research Reports
 
VANECK-PHARMA (PPH): ETF Research Reports
 
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