Health-care stocks may have fallen sick in July, but Franklin Global Healthcare remains the fittest fund, in terms of percentage growth, in the mammoth Franklin Templeton Group.
The sector fund has been run since inception by 29-year-old Kurt von Emster, one of the youngest portfolio managers in the mutual fund industry.
Global Healthcare started the year with $33 million; currently, assets total $145 million.
"July was very tough going for us and the market," said Mr. von Emster. The health-care market, as measured by his universe of 1,000 stocks, fell 6% in July; the fund plunged 10%, due to its high component of Nasdaq stocks.
But in August the fund surged ahead of the market and is up 16.3% for the calendar year through Sept. 17. The fund returned 27.92% for the year ended Aug. 30, and an average annual 28.61% for three years. It is among the top health/biotechnology funds tracked by Lipper Analytical Services, Summit, N.J., for the one-year period.
Since its inception, Feb. 14, 1992, it logged an average annual return of 16.4%, despite some rough years for the industry. Returns are net of expenses but not of sales charges.
Health care was the only industry sector that lost money for the year through Aug. 30, down 13.77%, according to Prudential Securities Inc. In the year to date, the sector was down 3.48%.
The summer correction in health-care stocks extinguished an initial public offering market that was burning out of control. Mr. von Emster said in the spring he was seeing five IPO roadshows a day. But he's seen only two or three all summer. "We're seeing reasonable valuations again. We're not seeing dog meat (priced) as a grade A steak."
Mr. von Emster thinks his fund, with its emphasis on undiscovered names, is a great diversifier for retail and 401(k) investors who are heavy in large-capitalization growth stocks.
Unlike the technology sector, "health care has more stable and predictable fundamentals .*.*. and the industry is technology-driven. We invest heavily in health-care information systems," he said.
"You can project the demographics of the market: how many pacemakers and cardiac patients there will be. There are 33 million individuals over the age of 65. That will more than double over the next 30 years, and the elderly spend four times more than the average person on health care," he said.
In fact, he thinks buying a health-care fund "is almost a hedge against your personal expenditures (on health care) like hedging your inflation risk by buying a gold fund."
Mr. von Emster predicts health-care expenditures will top $1 trillion in the United States this year. Expenditures internationally - led by Japan, Germany, France and the United Kingdom - will rise by 30% to 40%.
Although the portfolio is global, the U.S. represented 77.7% of fund assets as of Aug. 30.
The fund, rated five stars by Morningstar Inc., Chicago, seeks niche, underfollowed companies with a median market capitalization of $500 million. Companies in the portfolio have projected earnings per share growth of at least 15% over the next two years. Large-cap stocks comprise 10% to 20% of the fund.
Mr. von Emster likes to concentrate his bets and is currently reducing his holdings to about 55 from 70 at the end of August. "In the broad general run in the market in the last year or two, it was OK to own many names. Going forward, you need to be more selective," he said, noting some health-care funds hold as many as 200 names.
"We earn our management fee for being selective."
The expense ratio of 1.16%, including a 60-basis-point management fee, is moderate for a health-care fund. The average expense ratio for the group is 1.82%, according to Lipper.
"We don't do options or warrants or costly currency hedging," he said.
Annual turnover of about 100% - also moderate for a health-care fund - stems from Global Healthcare's strict sell discipline when stocks meet price targets.
Among its core holdings are the popular health-care stocks Amgen Inc., which it bought in June when it was trading at a price-earnings ratio of 16. The company has a 17% growth rate, according to Mr. von Emster.
"We'd loved Amgen for years but couldn't stomach the valuation 'til recently," he said.
Another stock he bought on sale in May, at an average cost of $41, is Boston Scientific Corp., which traded as high as $52 in March. It's now around $55 a share.
The fund's largest holding is Pacific Care Health Systems Inc., a health maintenance organization. His favorite stock is Serologicals Corp., the top supplier of specialty blood plasma, whose antibodies for hemophilia and hepatitis are in great demand from big pharmaceutical companies.
Among Global Healthcare's non-U.S. holdings are British Biotech PLC; Parkway Holdings Ltd., a Singapore hospital chain which might be an acquisition target; and several Israeli research and development and medical technology companies such as ESC Medical Systems Ltd., a company using phototherapy for skin treatment and hair removal.
His favorite sector is health care and hospital information systems companies. While the average company in the Standard & Poor's 500 Stock Index spends 5.5% of revenues on information systems, health-care companies spend only 2.5%. He expects that figure to double, boding well for firms like HBO & Co., which electronically links various patient records within a hospital.