Just as you can learn accounting and stock selection from the internet, I could have learned to fix a car. Every online video, short course, and textbook about automobile design exists right there online so that I would never need to pay a mechanic again. But I never have learned to fix a car, and I most likely never will. Part of it is fear, part of it is laziness, and part is just a simple gut feeling that this kind of work is best left to others.
Despite my firm belief that you are capable of picking winning stocks in the Big Pharma arena, maybe you just don’t want to. Never fear! There is a way that you can harness the explosive upside potential of Big Pharma without having to invest much time or effort at all.
You can buy an INDEX FUND. An index fund is a security, easily tradable on Etrade or through your broker, that represents a little bit of each stock in a category. For example, the most famous index of all is the original, the S&P 500 (invented in 1928). If you bought an S&P 500 index fund, then you would be buying one stock that is designed to mimic the investment returns of the combined 500 largest stocks traded on American exchanges. This is the investing equivalent of buying a self driving car; there is no active manager picking winning or losing stocks. There is only an algorithm that was designed to produce the same returns as a selected group of stocks.
Now would be a good time for a brief discussion about ACTIVE MANAGEMENT vrs. PASSIVE MANAGEMENT. Active management has existed for many decades, and it is exactly what it sounds like. The Investor buys a MUTUAL FUND, or a fund of stocks that is selected by an actual team of human beings who are entrusted with picking winning investments over long periods of time. These funds cannot be bought or sold on the blink of an eye, and management fees traditionally vary between .5% and 2% of the total sum of capital invested. Until about thirty years ago, active management was really the only way to invest in the stock market if you didn’t feel willing or able to pick stocks yourself.
Approximately thirty years ago, and new kind of investment was born. This method is call PASSIVE MANAGEMENT. As explained above, the concept is to pick a fixed list of stocks representing a certain sector, copy the results of that sector, and hope to match, rather than beat, the average for that sector. Investing costs are usually a fraction of the cost of active management because barely anybody works at these funds. Billions of dollars can literally be managed by a team smaller that your local high school basketball team.
Common sense would seem to dictate that a team of Harvard MBA’s with decades of investing experience would have to be able to beat a mindless, soulless algorithm that merely tries to match average sector performance. However, common sense has been proven wrong again and again. In recent decades even the best trained, best educated human beings have failed to beat passive management on a consistent basis. According to a stunning analysis by the Wall Street Journal, 92% of actively managed large capitalization stock funds failed to beat the S&P 500 over a 15 year time period, and 93% of small cap active funds failed to beat their prospective benchmarks over a 15 year period (20). Accordingly, more and more investors have abandoned the active management philosophy over time.
No one likes the word “average.” It’s just not sexy to tell anyone at a cocktail party, “my investments are performing at about the average return for the pharmaceutical sector.” However, you might start to reconsider the connotation of the word when we discover the astronomical returns that an “average” investment in Big Pharma has returned over the last decade or so.
Take for instance, the SPDR S&P Pharmaceuticals Exchange Traded Fund (ticker symbol, XPH). The fund description is as follows: “
The S&P Pharmaceuticals ETF seeks to replicate as closely as possible the total return performance of the S&P Pharmaceuticals Select Industry Index. The index represents the pharmaceuticals sub-industry portion of the S&P Total Markets Index. The S&M TMI tracks all of the United States common stocks listed on the New York Stock Exchange, American Stock Exchange, NASDAQ, and NASDAQ Small Caps exchange.
So, in plain English, XPH is a basket of pharmaceutical stocks that will represent the average return of a wide variety of common American pharmaceutical stocks. In the roughly decade long period between 2006 and January 1, 2017, XPH returned 11.62% annually, vrs just 5.3% for the S&P 500. In other words, a $10,000 investment in XPH 10 years ago would have left you with an impressive $31,820 today, while investing in the S&P 500 would have left you with half as much. Maybe average isn’t so bad if you pick the right average!!
Another similar index that you could have chosen would have been the iShares U.S. Pharmaceutical ETF (ticker symbol IHE). The company that offers the investment, iShares, describes the index simply as “…exposure to U.S. companies that manufacture prescription or over the counter drugs or vaccines…targeted to access the domestic pharmaceutical market.” If you had invested in IHE in 2006, you would have received a stellar 12.24% annualized return, meaning that you would have transformed $10,000 into $33,953!! Now that is starting to look like cocktail party bragging rights….
Yet another index that you could have chosen would have been the Powershares Dynamic Pharmaceuticals Portfolio (ticker symbol PJP). This index is similar to the other two mentioned above, with the one exception that their algorithm allows for somewhat smaller, somewhat riskier companies to be included in the mix. Although the index is filled with “heavy hitters” such as Pfizer and Bristol Meyers Squibb, this particular index also included names such as Gilead, Amgen, and Akron, which were somewhat more speculative ventures at the time that the index was formed in the mid 00’s. The results of this slight tweak towards risk? An astounding annualized return of 13.24%, which would have nearly quadrupled your $10,000 investment in just 10 years ($10,000 invested in 2006 would have equaled $38,863 on January 1, 2017). If you don’t call that return sexy, you may need to get your pulse checked.
The moral of the story is: Big Pharma is a great business to own. You can follow the tips mentioned in this chapter to pick your own winning bets, or you can employ any one of the indexes mentioned to join the market’s inevitable march towards investment victory. The only way to lose is by not investing for the long term. In today’s world, you, as a citizen and an investor, are confronted by a simple choice; pay for the medical innovation that you will eventually need, or get paid by it. Anyone with $1000 in their pocket can join in the scientific revolution that is happening in laboratories across the world. Don’t let all the profits of scientific progress go to the Wall Street sharks; use the knowledge in this chapter to make sure that you get more than just bills from your pharmacy. You’re smart enough, you’re tough enough, and now you can get your piece of the action!