When 2022 Tore Through the S&P 500, This Healthcare ETF Barely Flinched. Why Isn’t It in More Retirement Accounts?

A lot of investors tend to think about the S&P 500 index as one giant monolith, but I think it becomes much more interesting once you break it down into its component sectors: technology, healthcare, financials, consumer discretionary, communication services, industrials, consumer staples, energy, utilities, materials, and real estate.

Out of these 11 sectors, three are generally regarded as defensive: consumer staples, healthcare, and utilities. The reason mostly comes down to inelastic demand. People still need medicine, electricity, toothpaste, groceries, and household essentials regardless of whether the economy is booming or entering a recession.

That tends to create steadier earnings profiles and lower volatility during market downturns. And importantly, this effect has been fairly consistent regardless of what actually caused the downturn in the first place. We saw it during the dot-com crash, the 2008 financial crisis, the 2020 COVID-19 selloff, and again during the inflation-driven bear market of 2022.

So I am a little perplexed as to why more lower-risk investors or retirees with shorter time horizons do not overweight these sectors more often. Yes, there is absolutely a case for simply sticking with market-cap-weighted index funds and benefiting from the momentum effect, simplicity, and low fees. But in a market increasingly dominated by mega-cap technology stocks, I think there is room for a middle ground between going all-in on buffer ETFs, bonds, or sitting entirely in cash.

The Healthcare ETF in Question

One ETF that I think fits that role particularly well is the Vanguard Health Care ETF (NYSEARCA: VHT), largely because it combines broad diversification with extremely low fees. It is one of Vanguard’s 11 sector-specific ETFs and, like most Vanguard products, remains very affordable with a 0.09% expense ratio. On a $10,000 investment, that works out to just $9 annually in fee drag.

In exchange, you get exposure to more than 400 U.S.-domiciled healthcare companies weighted by market capitalization. That said, the ETF still tilts heavily toward large-cap companies, with a median market capitalization of roughly $158 billion. In practice, that means you are getting a portfolio dominated by established pharmaceutical firms, healthcare providers, medical device companies, and biotech giants rather than highly speculative early-stage names.

The portfolio metrics are fairly solid too. As of April 30th, VHT traded at 28.8 times earnings, which is not exactly cheap, but quality and upside remains decent with an average 19.8% return on equity and a respectable 9.4% earnings growth rate.

One of the best ways to quantify the defensive characteristics of an ETF is by looking at beta, which measures sensitivity to the broader market. According to Yahoo Finance, VHT currently has a five-year monthly beta of 0.64. Compare that to the S&P 500’s beta of 1.0, and you can immediately see why healthcare has historically been attractive for investors looking to dampen portfolio volatility without completely abandoning equities.

What the Data Says About VHT in 2022

Testfolio.io has a useful backtesting tool, and I compared VHT against the SPDR S&P 500 ETF Trust (NYSEARCA: SPY) over the entirety of 2022. The results were striking. By year-end, SPY had declined 18.17% on a total return basis, while VHT was down just 5.62%. In other words, VHT lost less than one-third as much as the broader market.

Volatility was meaningfully lower as well. SPY recorded annualized volatility of 24.19% during that period, whereas VHT came in lower at 19.90%. And the interesting thing here is that during an inflationary, rising-rate environment where bonds struggled badly, healthcare equities actually held up better than many traditional fixed-income allocations retirees normally rely on for defense. That does not mean healthcare stocks are risk free. They still face sector-specific risks like drug pricing regulation, patent cliffs, reimbursement changes, and biotech volatility.

But I do think this highlights an important point: diversification is not just about balancing between different asset classes; there is also a case for being more selective within an asset class itself. And if your goal is reducing volatility while still maintaining meaningful exposure to equities, allocating part of your portfolio toward a healthcare ETF like VHT could be a very sensible defensive tilt.