These ETFs Should Love The Pfizer-Allergan News

In what could amount to the biggest takeover of a U.S. company in over a year, Dow component Pfizer Inc.(NYSE:PFE) is reportedly mulling an acquisition of specialty pharmaceuticals maker Allergan Plc(NYSE:AGN).

"Pfizer recently approached Allergan about a deal, according to people familiar with the matter, with one of them adding that the process is early and may not yield an agreement. Other details of the talks are unclear," reports The Wall Street Journal.

Allergan closed with a market value of about $113 billion on Wednesday. Pfizer's market value at Wednesday's close was nearly double that. New York-based Pfizer had nearly $30.3 billion in cash on hand at the end of the second quarter.

As is par for the course with healthcare sector deal-making, a batch of exchange traded funds stand to benefit, particularly if Pfizer can stomach what is likely to be a rich takeover price for Allergan. Among the ETF beneficiaries of the news, perhaps none standout more than the $917.7 million iShares U.S. Pharmaceuticals ETF (NYSE:IHE).

Pharma ETF

Really, it is about simple math for ETFs when it comes to benefiting from takeover talk and the math favors IHE. As of October 27, Pfizer and Allergan were IHE's second- and fifth-largest holdings, respectively, combining for more than 17 percent of the ETF's weight.

Further examination of IHE's 43-stock roster reveals that roughly a quarter of the ETF's holdings are credible takeover targets and/or have already been rumored to be just that while a comparable amount of the ETF's lineup are legitimate buyers.

Beta Spin

The PowerShares Dynamic Pharmaceuticals Portfolio (NYSE:PJP), a strategic beta spin on pharmaceuticals ETFs, is another ETF that cannot be overlooked as Pfizer mulls a marriage with Allergan. Pfizer and Allergan are PJP's second- and eighth-largest holdings, combining for nearly 11 percent of the ETF's weight.

PJP's underlying index "is designed to provide capital appreciation by thoroughly evaluating companies based on a variety of investment merit criteria, including: price momentum, earnings momentum, quality, management action, and value,"according to PowerShares.

Like IHE, PJP is chock of healthcare buyers and sellers because the ETF allocates nearly two-thirds of its weight to large- and mega-cap stocks with the remainder going to small-caps. More than 10 percent of PJP's $1.6 billion in assets under management have flowed into the ETF over the past year, meaning only 11 PowerShares have added more new assets over that period.

More importantly, PJP has risen more than five-fold over the past decade, making it the best-performing U.S. ETF over that span. A big reason behind PJP's decade of dominance has been, not surprisingly, healthcare mergers and acquisitions activity.