The appeal of finding the right biotech stock is self-evident.
If you get it right, and a cutting-edge biotech scores a major win
with a breakthrough drug treatment, then you can score huge gains.
Last month, I reviewed my performance over the course of 2011 in
hopes of gleaning important new lessons for the coming year. Chief
among those lessons: avoid companies that will need fresh
injections of capital to keep afloat. I singled out the biotech
sector, which not only faces the prospect of an uncertain economic
environment in which to raise money, but is headed by executives
who are simply clueless about how
works. So many biotech stocks waited far too long to raise money
have fallen 50% or even 75% in the past year on fears of a
liquidity crunch by the time they finally raised needed funds. The
for these firms has been stunning.
The current year should bring more of the same. Many of these
companies raised about a years' worth of fresh capital in 2011 and
will need to reload the
once again in 2012 -- at likely depressed levels, implying even
more painful dilution.
Sadly, for every biotech stock that takes off sharply, another
half-dozen plunge to new lows because of nature of these
cash-constrained business models.
Instead, it seems far wiser to simply own a basket of biotech
stocks in order to gain exposure to this still-promising sector.
This limits upside when compared with the potential of a single
high-flying biotech company, but also greatly reduces risk.
Let's take a look at a few options.
1. iShares Nasdaq BiotechnologyIndex (NYSE:
This fund is hitting all-time highs and isn't really the right
vehicle for those who want exposure to the most dynamic aspects of
the biotech industry. It holds stakes in large well-established
Gilead Sciences (Nasdaq:
Teva Pharmaceuticals (Nasdaq:
and others. These companies are increasingly becoming similar to
Big Pharma stocks, as the top-line growth rates are no longer
really impressive. The
(M&A) angle is always part of the broader biotech theme, but
these biotechs are now so large that they are likely too big to be
gobbled up by Big Pharma because of their existing
A similar logic applies to the
Market Vectors Biotech ETF (NYSE:
ProShares Ultra Nasdaq Biotechnology ETF (NYSE:
. All of these funds are hitting their peaks and would have been a
lot more appealing a year or two ago.
2. First TrustAmex Biotech Index (NYSE:
This fund moves down the food chain by owning more of the
middle-tier biotech firms and has a smaller emphasis on the
industry's top players. For example,
United Therapeutics (Nasdaq:
Nektar Therapeutics (Nasdaq:
, and Illumina (Nasdaq:
) are the top three holdings. The fact that Illumina has just
Roche Holdings (Pink Sheets : RHHBY)
tells you these companies aren't too large to get caught up in the
"[This fund] is skewed more toward smaller-cap, early-stage
biotech firms (which have decidedly uncertain prospects but
explosive upside potential). In fact, almost half of the names in
this ETF are companies with no drug on the market yet." Morningstar
analysts note. They recommend the fund, but note it brings
high-risk along with high reward, adding that its exposure to
"small-cap names to have a greater impact on returns, and this has
helped the ETF's returns outperform its peers in some periods."
3. PowerShares Dynamic Biotech & Genome INtellidex SM
This fund moves even further out on the risk curve, yet is more
capable of delivering strong returns if investors flock to the
speculative end of the biotech sector. Roughly half of the holdings
are early-stage biotechs that have yet to land a drug on the
market. As is similarly the case with other exchange-traded funds
(ETFs) noted above, this fund carries an
of 0.63%, well below the fees sought by a biotech-focused
4. T. Rowe Price Health Sciences fund (Nasdaq:
As mutual funds go, this one's 0.84% annual expense ratio isn't too
bad. Better still, the performance has been consistently good when
you consider its
takes positions in smaller, risker biotechs alongside the larger,
more traditional picks. The fund rose 32% in 2009, 16% in 2010 and
11% in 2011. It gets a gold rating and four stars from Morningstar.
Risks to Consider:
The funds that focus on smaller biotechs would take a real hit
if the market turned south. For example, the T.Rowe Price fund
noted above sank 29% in 2008 when the broader market hit the skids.
As a result, the more speculative biotech funds should only be seen
as long-term investments. In addition, the major biotech ETFs,
which own the industry's blue chips, are hitting fresh highs. Some
of their key holdings may be ripe for profit-taking.
Action to Take -->
Though the chance to score huge gains with just one biotech stock
holds great allure, few investors manage to get it right and find
the one stock that really breaks out. Instead, investors should go
with the basket approach that these funds offer.
If you haven't heard about this unique opportunity, then I want to
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-- David Sterman
David Sterman does not personally hold positions in any
securities mentioned in this article. StreetAuthority LLC owns
shares of GILD in one or more if its "real money" portfolios.