Health care funds cure portfolio pain in 2013

Health-care funds soared again in 2013, but some worry about the stocks' feverish gains.

The average health care fund leaped 48.3% in 2013 through Friday, vs. a 33.4% gain for the average stock mutual fund, according to Lipper.

"It's more impressive when you take into account that this is the third consecutive year that health care has outperformed," says Jeff Loo, equity research analyst for Standard & Poor's.

The health care sector was playing catch-up in 2011 and 2012, when the sector was undervalued relative to the broad S&P 1500, Loo says. Because of this year's runup, that's no longer the case. Health care stocks sell for about 16.6 times estimated 2014 earnings now, vs. 15.2 for the S&P 1500. "They're not cheap anymore," Loo says.

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Leading the way: Biotechnology, up 57.6% this year and an average 33.53% a year the past three years, according to Morningstar. "Biotech has been a complete monster," Loo says.

When you get three such big years in a row, "Talk starts turning to bubble talk," says Steven Silver, biotech analyst for S&P. "I would argue that we're not in a bubble, but are in a significant runup because of an improving long-term growth outlook."

One big improvement: Several promising new drugs have been given Food and Drug Administration approval. The standout: Sovaldi, a treatment for hepatitis C, which affects about 170 million people worldwide. The treatment is a single daily pill, rather than a series of injections. "It could be one of the best-selling drugs in history," Loo says.

Other promising drugs in the biotech pipeline include a drug from Vertex Pharmaceuticals for cystic fibrosis. Other companies are working on gene therapy solutions for cancer.

Another factor for biotech's growth: Merger and acquisition activity. Big drug companies sometimes prefer to buy a smaller company with a! promising drug or productive research department.

Finally, analysts say the FDA has been more accommodating in the past few years, shortening the long approval time for new drugs and treatments.

But it hasn't been all biotech: Most subsectors of the health sector care performed well in 2013. For example, drug manufacturers rose 30.9%, according to Morningstar, while medical device makers gained 36.8%.

Health care plans, such as prescription drug plan Express Scripts, have gained an average 39.7%, despite problems with the rollout of the Affordable Care Act.

The prospects for 2014 depend, in part, on how enrollment for health care plans fares. Because of the glitches with the health care exchanges, fewer people – and fewer healthier people – have enrolled for insurance. "That could hold back gains for health care next year," Loo says.