Small-Cap Healthcare ETF: A Baby Thrown Out With The Bathwater

The healthcare sector, the third-largest sector weight in the S&P 500, is the midst of a stunning first-to-worst act. What was once the best-performing sector in the S&P 500 is seeing those gains rapidly evaporate, led by a severe repudiation of biotechnology stocks and exchange traded funds.

In what would have been an unthinkable statistic a few months ago, seven of the 11 worst-performing ETFs, including the five worst, over the past five days are healthcare funds. Cementing the cruelty currently being faced by healthcare ETFs, the only ETFs that made new highs on Monday were two inverse biotech funds.

Investors with the temerity to search for a potential healthcare rebound candidate might want to have a look at the $253.1 million PowerShares S&P SmallCap Health Care Portfolio (NASDAQ:PSCH). An easy way of explaining PSCH is that the fund is the small-cap equivalent of the Health Care Select Sector SPDR (NYSE:XLV), the largest healthcare ETF.

A case can be made that down 8.5 percent over the past week, PSCH is the baby being thrown out with the healthcare sector bathwater. It is easy to understand why. When some market participants think small-cap healthcare, they think biotech. After all, a raft of biotech IPOs in recent years are still small-caps, boosting the Russell 2000's healthcare weight to 16.1 percent, the benchmark small-cap index's third-largest sector allocation.

However, PSCH is not particularly heavy on biotech stocks. At 8.9 percent of PSCH's weight, biotech is merely the ETF's fourth-largest industry weight, well behind the 15.5 percent allocated to pharmaceuticals stocks.

PSCH has significantly lagged the Russell 2000 over the past week, but the small-cap healthcare has also been 380 basis points less bad than the iShares Nasdaq Biotechnology ETF (NASDAQ:IBB), the largest biotech ETF, over that period.

Hillary Clinton's now infamous tweet proved damaging to biotech and pharmaceuticals stocks and that is not good news for an ETF that allocates almost a quarter of its weight to those industries as does PSCH.

The real culprit behind PSCH's decline has been medical device and equipment manufacturers, a particularly volatile group in the world of small-caps. The iShares U.S. Medical Devices ETF (NYSE:IHI), primarily a large-cap ETF, has shed 6.7 percent over the past week. Medical device makers are PSCH's largest industry weight at almost 35 percent.