Sam Mamudi of MarketWatch talks with some portflio managers about which health care stocks they like currently. Health-care stocks keeping portfolios in shape

NEW YORK (MarketWatch) -- At a time when stocks are weak across the board, one sector has been strong enough to help mitigate some of the worst losses.

Health-care stocks have performed better than their counterparts in other industries due to steady demand, strong earnings and finances, and expectations of industry consolidation.

While the sector has long been viewed as defensive, it's notable that health care's success comes even as other traditionally defensive sectors have been hurt in the broader downturn.

"There aren't a lot of places where you can put money and be comfortable right now, but health care is one of them," said Dean Kartsonas, manager of Federated Capital Appreciation Fund (FEDEX), which is heavily committed to the sector. "It's kind of the lone wolf."

Other defensive sectors, such as telecommunications and consumer staples, are beset by their own problems, Kartsonas said. Telecoms are under attack from cable operators, while consumer staples have suffered from cash-strapped consumers shunning brand-name goods, and the strong U.S. dollar slow international demand.

Market medicine
Health-care mutual funds are by far the best of a sorry bunch of sector funds, landing in the plus column and leading rivals so far this year as of Feb. 12, according to investment researcher Morningstar Inc. Health-care funds are up 2.8% -- the only domestic-stock fund sector other than technology in the black. Health care's outperformance is due in part to strong demand from an aging population.

"People are hard-pressed to cut out their health expenditures," said Christopher Davis, analyst at Morningstar.

But there are also structural reasons for the sector's improvement. Kartsonas said that while demand helps health-care firms' earnings, these companies also have strong balance sheets and reasonably priced shares. Industry observers also expect an uptick in mergers and acquisitions on the heels of Roche Holding AG's (RHHBY) attempt to buy Genentech Inc. (DNA) outright and Pfizer Inc.'s (PFE) tie-up with Wyeth (WYE).

"A lot of the larger companies have cash, and also drugs that are coming off patent," said Kartsonas. As a result, they're attracted to rivals with a rich pipeline of new products.

Health-care sector mutual funds have lost 16.8% on average in the 12 months through Feb. 12, but that is far superior to its nearest sector rival, utilities funds, which were down 31.4% on average, and also surpasses the 36.5% decline for the Standard & Poor's 500 Index (SPX).

But results are not strong across all areas of the health-care industry.

"Some sub-sectors are less susceptible to recession than others," said Vijay Shankaran, manager of Touchstone Healthcare and Biotechnology Fund (THBCX).

For example, the Nasdaq Biotechnology Index (NBI) was down 12.5% in 2008, while the Morgan Stanley Healthcare Providers Index (RXH), which tracks hospitals and medical and nursing services, tumbled 32%.

"We're staying away from stocks of companies that sell big-ticket equipment," added Rose Ott, manager of Alger Health Sciences Fund (AHSAX).

Ott said she's looking at health-care stocks with less capital-equipment exposure and greater focus on consumables and non-elective procedures -- companies such as Covidien Ltd. (COV) and C.R. Bard Inc. (BCR). Covidien makes commodity-like medical products, such as connecting tubes, she noted, while Bard doesn't rely on one particular product for its revenues.

Bartlett Geer, manager of Putnam Equity Income Fund (PEYAX), said health care is his biggest overweight sector relative to his benchmark, the Russell Value 1000 Index. One of his favorites is Amgen Inc. (AMGN).

"We're excited about their [experimental] osteoporosis drug, Denosumab," Geer said. He said Amgen had been hit with concerns about sales of its anemia drugs, but "those issues have been stabilized." Geer added that Amgen also has no net debt and the stock "represents a growth opportunity."

Touchstone's Shankaran named two drug companies that he likes in part because their products don't "face price pressures." Gilead Sciences Inc. (GILD) has HIV-controlling drugs that aren't the most expensive line-item for patient costs, Shankaran said, while Alexion Pharmaceuticals Inc. (ALXN) has a drug, Soliris, that is the first specific treatment for the rare disease paroxysmal nocturnal hemoglobinuria (PNH).

Shankaran echoed Ott and said he also owns diversified medical suppliers that offer basic items such as syringes and tubes. These companies, such as Baxter International Inc. (BAX) and Becton Dickinson and Co. (BDX), are not only doing better than most of the sector, but also growing revenues. Shankaran said what greatly helps this sub-sector is that hospitals view paying for their products as operating costs, rather than capital costs.

Legislative fears
If there is one cloud on the horizon for the health-care sector, it's the fact that the Democratic Party's control of government suggests reform of the industry is on its way. But managers' opinions are divided about what reform might actually mean for the sector.

Portfolio prescription
"Everybody should have exposure to health-care stocks," said Morningstar's Davis. "But few people need health care-specific mutual funds."

Davis suggested a 5% portfolio allocation to the sector, and noted that investors with diversified stock funds might already be there, especially since many managers have embraced health care.

Disclosure: The Div Guy owns shares of PFE and BDX at the time of this post.