Why is Vanguard Health Care Fund Investor Shares rated at the highest risk, level 5? Is it because it is all in one category (health care in general)?
Since inception, and at all benchmark years (1, 3, 5, and 10) VGHCX seems to handily outperform VTSAX which is level 4 risk.
Given the aging population and ever increasing medical costs, what could cause VGHCX to perform worse than VTSAX?
Yes it is a 5 because it is all in one sector. It isn't diversified. Even VDC(consumer staples) is a 5 because it is a sector fund even though consumer staples tend to hold their value pretty well in a recession.
I can think of plenty of reasons VGHCX would perform worse than VTSAX. The most obvious is that too many people are thinking the same way you do. When everyone knows about increasing medical costs and an aging population people start to assume healthcare will do better. Essentially people have driven up the price of healthcare companies past that of the general market.
VGHCX PE ratio= 35.8
SP 500 index PE ratio= 20.9
VGHCX is priced 71% higher compared to earnings than the SP 500. You need a lot of future growth to justify that.
So the market has already priced in the expectation that healthcare will do better. So what happens if health care companies don't significantly outperform everything else? What would happen if their growth was just the same as everything else? Well since more growth is already priced in if that extra growth didn't happen healthcare would perform poorly compared to the general market.
Past example: Tech stocks in the late 90s. Everyone assumed they would do well and started ignoring the risks. Healthcare hasn't hit that extreme, but it is the same general idea.