Legal Troubles Beset Pharmaceutical Sector ETFs

Pharmaceutical ETFs may be in trouble with legal troubles looming over the industry.

The drugmaker segment recently sold-off after an amended civil antitrust complaint brought by more than 40 state attorneys general alleged that 15 individuals and 20 corporate defendants conspired to fix prices on over 100 generic drugs, the Wall Street Journal reports.

Teva Pharmaceutical Industries (TEVA) and Mylan (MYL) were among the hardest hit by the recent allegations.

The potential for greater legal risk could also dampen the outlook on pharma-related ETFs, such as Invesco Dynamic Pharmaceuticals Portfolio (NYSEArca: PJP), SPDR Pharmaceuticals ETF (NYSEArca: XPH), iShares U.S. Pharmaceuticals ETF (NYSEArca: IHE), VanEck Vectors Pharmaceutical ETF (NYSEArca: PPH) and VanEck Vectors Generic Drugs ETF (NasdaqGM: GNRX).

While some may argue that drug prices are getting out of control, an industry trade group accurately pointed out that generic-drug prices have actually been in decline for years. Furthermore, total generic-drug spending accounts for a fraction of overall drug costs and only amount to a rounding error in the context of total U.S. health spending.

Market observes may point out that the loss of industry pricing power was priced into stocks long ago with several drugmaker stocks now more than 70% below their highest close. However, potential value diggers should keep in mind that a finalized verdict or settlement agreements are years away.

Under the Affordable Care Act, health insurers are faced with fixed profit margins, so they can make higher overall profits in those programs if health spending rises. Consequently, health-care inflation is no surprise given the current circumstances. Meanwhile, for investors, it means that the system maximizes access to health services without meaningful cost-control tools.

Looking ahead, the sector, which has underperformed the S&P 500, will likely continue to fall behind if the risk of disruptions such as legal troubles rises.

For more information on the pharma sector, visit our pharmaceuticals category.

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