I have always loved biotech. I got my start in this industry as
a biotech analyst for an actively managed mutual fund, and spent a
number of fun years working at Genzyme, one of the largest biotech
companies in the world.
For the past few years, however, watching biotech has been like
watching paint dry. The broad-based iShares Nasdaq Biotech ETF
(NYSEArca:IBB) is trading exactly flat over the past 10 years.
That's astonishing, considering how the biotech industry has
evolved. In 2001, the biotech industry was full of hopes and
dreams; companies with no revenues but big opportunities. Today
it's full of hugely profitable and fast-growing companies like
Celgene, which expects revenue to grow from $3.6 billion to more
than $5 billion over the next year.
Biotech also has badly lagged U.S. equities since the market
bottom on March 9,
2009, with IBB rising "just" 62 percent against a rise of more than
100 percent for the S&P 500.
Yesterday, however, my former employer Genzyme inked a $20
billion buyout deal with Sanofi-Aventis, sparking renewed interest
in the sector. Many analysts expect more pharma/biotech mergers in
the future. Other eternal optimists (like me) expect biotech growth
to surprise on the upside generally in the coming years, as early
insights into genomics finally start turning into products.
There are five choices for ETFs in the biotech space, and they
vary widely. Choosing the right one will have a big impact on
Choice 1:iShares Nasdaq Biotech ETF
IBB is the oldest and largest biotech ETFs. It was first-to-market,
has the best liquidity and, with $1.3 billion under management, is
by far the biggest.
IBB tracks a market-cap-weighted measure of the biotech sector,
meaning it puts the bulk of its assets into the largest, most
established biotech companies. For example, it has a 7.4 percent
position in Amgen.
This is important because the biotech industry is bifurcated.
There are a dozen or so large, well-established and hugely
profitable biotech companies, like Amgen, Gilead, Genzyme and
Celgene, that dominate market-cap-weighted indexes like the one IBB
tracks. These companies are best thought of as biotech/pharma
hybrids:They share some of the excitement of early-stage biotech
start-ups, but also some of the challenges of the pharmaceutical
industry, including slow-growing older products, the need to
reinvigorate development pipelines, etc. The other half of the
industry is composed of earlier-stage start-ups-generally smaller
companies with more promise than profits.
IBB's focus on large-cap stocks should make it more stable than
other funds. In addition, large companies like Genzyme are
attractive acquisition candidates right now, as they are large
enough to move the needle in terms of revenue and profit for major
If the bio/pharma merger parade really starts moving, IBB could
be a good choice.
Choice 2:SPDR S&P Biotech ETF (NYSEArca:XBI):
XBI is the second-most-popular biotech ETF, with $428 million in
assets under management. XBI tracks an equal-weighted index of 30
biotech companies. That means it puts an equal amount of money into
a $50 billion giant like Amgen (
) as it does into an $800 million small-cap like Acorda
This has the effect of de-emphasizing the biopharmaceutical
giants in favor of earlier-stage, riskier small-caps. That means
added risk, and potentially added rewards, although less exposure
to massive biotech buyouts like Genzyme.
Choice 3:First Trust NYSE Arca Biotechnology ETF
FBT is a very interesting third option, and is quickly gaining
ground on popularity compared to XBI.
Like XBI, it tracks an equal-weighted index of biotech
companies. It's more concentrated than XBI, holding just 20
securities, and focuses heavily on drug development companies.
FBT has been by far the best-performing biotech ETF over any
recent time frame you measure. The fund is up almost 90 percent
over the past two years-nearly triple the return of IBB and over
four times more than XBI's return. When you hold a focused
portfolio of just 20 names and you get those names right, you do
I continue to like the looks of FBT's portfolio. It's a classic
play on early-stage drug discovery, de-emphasizing the Amgens of
the world in favor of potentially more interesting developing
FBT has $217 million in assets.
Choice 4:PowerShares Dynamic Biotechnology & Genome
PBE is a relatively small fund with just shy of $200 million in
assets under management. It tracks a quant-driven index that
selects 30 biotech companies based on a variety of fundamental and
technical measures, including valuations and momentum.
The portfolio has significant turnover, so there's not much use
to actually studying its holdings. What it owns today is not what
it will own next quarter. If you buy PBE, you're buying into its
quant-based screening mechanism, which broadly speaking tilts
toward small-cap companies and in favor of tool providers
rather than drug-discovery companies. The reason is simple:Tool
providers are often more profitable and therefore do better on
certain fundamental measures than drug-discovery firms.
Also, the quant algorithm behind the PowerShares Dynamic ETFs
tends to do better in some markets than others. Biotech isn't one
of its strengths-probably because some of the most interesting
companies don't have either revenues or profits-and PBE's
performance has suffered as a result.
Choice 5:Biotech HOLDRs (
The fifth choice is the biotech holders, or BBH. Like most HOLDRS,
BBH is not a well-structured fund. HOLDRs are unable to rebalance
their portfolios, which were set up in the mid-1990s. This
"frozen-in-time" element means that most HOLDRs have huge
concentrations in certain stocks, as whatever companies did well in
the late-1990s and early 2000s gained a dominant share of the
That's decidedly the case here:Amgen is 33 percent of the fund,
Gilead is 25 percent and Biogen Idec is 18 percent. This strong
concentration can lead to strong performance-BBH popped nicely when
Genzyme was acquired, as it had a 10 percent position in the
name-but it's random and arbitrary. If you want exposure this
concentrated, buy single stocks instead.
There are a number of good choices in biotech. If you want
broad-based exposure that tilts toward large bio-pharmaceuticals,
IBB is a good choice. If you want more pure-play exposure to
earlier-stage drug-discovery firms, a fund like FBT or possibly XBI
rises to the top. PBE offers exposure to biotech tool providers,
although the performance is variable. And BBH … well, there's not
much good to say about BBH.
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