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McCall’s Call: The Cancer-Cure Biotech ETFs

Posted
6/17/2010 11:34:00 AM
By: IndexUniverse
Referenced Stocks:BBH;FBT;IBB;PBE;XBI

The future growth of the biotechnology and pharmaceutical sectors will hinge largely on advances made in cancer treatment, and biotech firms in particular look likely to reap the benefits of any cancer.

Matthew D. McCall That's not to say curing cancer is anything but a colossal challenge, largely because cancer is many diseases that happen to share the same name. Researchers are discovering that not only does each cancer require specific drugs, but even the stage at which the patient has the disease can affect the type of drug prescribed.

Still, drug companies have been saying they're optimistic about potential treatments in the pipeline, even as they remain realistic about the timing and costs of advancing the fight against cancer.

Investors can choose among nine ETFs to gain exposure to drug and biotech companies. Five of them focus solely on biotech and four others consider themselves pharmaceutical ETFs. Because I feel the future of the fight against cancer will begin with the biotech stocks, as opposed to Big Pharma, I'll focus on the five biotech ETFs.

The Two Main Players

The most popular of the five biotech ETFs is the iShares Nasdaq Biotechnology ETF (NasdaqGM:IBB), which trades about 463,000 shares per day and is composed of 128 biotech stocks. The top holding, Amgen (NasdaqGS:AMGN), is a behemoth in the biotech sector. It makes up 9 percent of the allocation in a portfolio where the Top 10 holdings account for 46 percent. The expense ratio is an acceptable 0.48 percent, and the high diversity among biotech stocks makes IBB attractive to large investors.

The second-most popular biotech ETF is the SPDR S&P Biotech ETF (NYSEArca:XBI), which trades approximately 156,000 shares per day. This ETF has just 28 stocks, but its biggest position makes up less than 5 percent of the total allocation. Regeneron Pharmaceuticals (NasdaqGS:REGN) and Seattle Genetics (NasdaqGM:SGEN) each account for 4.61 percent of the ETF and the top 10 holdings total 43 percent. XBI's expense ratio is 0.35 percent.

The Rest

The Biotech HOLDRS ETF (NYSEArca:BBH) is composed of only 12 stocks, with the top six holdings making up 96 percent of the allocation. Amgen accounts for 38 percent and Gilead Sciences (NasdaqGS:GILD) makes up 26 percent. The extremely high concentration makes BBH a one-of-a kind security in the sector.

The last two biotech ETFs are not terribly popular among investors, and each trades less than 20,000 shares per day on average. The First Trust NYSE Arca Biotech ETF (NYSEArca:FBT) and the PowerShares Dynamic Biotech ETF (NYSEArca:PBE) give investors two more options. The FBT is similar to XBI in that it is composed of 20 biotech stocks and it doesn't have an individual weighting above 5.6 percent. PBE is made up of 31 stocks, but the holdings vary greatly from its peers because it invests in firms that aren't considered biotech companies by many. For example, the ETF's largest holding is Sigma-Aldrich (NasdaqGS:SIAL), a diversified chemicals company that supplies products to the biotech sector.

Comparing And Choosing

The composition of the five biotech ETFs vary greatly and, as expected, so do their returns.

In 2007, a year when the S&P 500 gained 3.5 percent, the return for these biotech ETFs ranged from -12 percent to +29 percent. The differences in returns are huge, considering we're only talking about 12 months. BBH, the one with just 12 positions, was the loser due to weak performances from its top holdings, which it lives and dies with. Conversely, XBI was the big winner due to its diversification.

In the following year, 2008, BBH rose from the cellar to become the best performer, gaining 10 percent. PBE, the PowerShares ETF, pulled up the rear with a loss of 27 percent. Keep in mind the S&P 500 lost more than 38 percent during the year.

Last year, all five ETFs were in positive territory along with the overall market. However, the differences were again huge. XBI only gained 1 percent; FBT surged 45 percent. The three-year annualized returns show FBT as the top performer, gaining an average of 7.8 percent, with XBI the other winner in the three-year returns contest, with annual gains of 0.8 percent.

Now on to why I own XBI, and why I prefer biotech ETFs over biotech stocks for individual investors. My firm owns XBI due to its lack of concentration in one position and the allocation into a number of mid-cap stocks with big potential. The reason I prefer an ETF over an individual biotech stock can be better told in numbers.

In 2009 investors had a 2-in-3 chance of picking a biotech stock that would have beaten the Dow Jones Biotech Index's 5 percent return. They also had a 23 percent chance of picking a stock that was down at least 10 percent, and a 13 percent chance their stock would have lost at least 30 percent. Believe it or not, there was a 6 percent chance your biotech stock lost over half its value in a year the S&P 500 gained 23 percent.

I think I've made my point:Stick with the ETFs, not stocks.

Matthew D. McCall is editor of The ETF Bulletin and president of Penn Financial Group LLC, a Ridgewood, N.J.-based wealth management firm specializing in investment strategies using ETFs.

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