HOW TO SUCCEED IN BIOTECH WITHOUT REALLY TRYING

biotech etfs

So you’ve just gotten back from your latest condo board meeting, and you’ve realized that most of the board members that should have been dead twenty years ago just keep living and living. Or you just read the announcement that singer Tony Bennett, who had been friends with Frank Sinatra, will continue touring despite the fact that he is now almost a century old. Or you’ve been reading my blog, and I’ve finally convinced you that the “Grey Tsunami” is real. (I’ll say it once again just for effect. 10,000 people per DAY now get Medicare in the USA.).

At any rate, you have decided to put your hard earned investment funds into healthcare. But the details are overwhelming!! You’re not a doctor, or a PhD, or a pharmacist. And while those biotech stock charts look juicy, you are a busy executive, a stressed out Mom, or just too interested in enjoying a gorgeous day to spend the time scrutinizing GAP accounting and press releases. It worries you that the next cure for cancer might wind up a bust, and poof! There goes the funds that you worked so hard to accumulate. What to do?

Never fear, the Biotech ETF is here!

If you fit the above description, the Wizards of Wall Street have created a wide variety of exchange traded funds just for you. These products will help you harness the explosive growth power of biotech investing while limiting your downside risk. After all, it’s easier to dream of biotech riches when you can sleep well to begin with.

Biotech ETFs: Engineered for you

An exchange traded fund (ETF) is typically one stock ticker that is designed to mimic an underlying index, or basket of stocks. Within the same sector or subsector, the underlying basket of securities can have slightly different, or very different, designs, which can result in different risk profiles, and different investment outcomes. Here we will be discussing four different ETFs plus a comparator that tracks the larger pharmaceutical stock universe. As you will see, ANY of these four options will give you robust exposure to the wonder that is biotech; it’s simply a matter of which ETF best suits your exact needs. All of the following biotech ETFs exhibit certain “pros and cons” versus direct investment in individual biotech stocks.

Pros:

1) Very unlikely to go to $0. When you buy an individual biotech stock, the upside is virtually endless, but so is the risk of total loss. Small, fragile biotechs that are testing the outer limits of science can, and do, go bankrupt. However the overall market just isn’t going anywhere. So if you buy a basket of 30 biotech stocks, which is what most ETFs represent, it’s very hard to lose all of your investment.

2) Set it, and forget it. Once you have chosen an index that you are comfortable with, you could literally buy it and not check it for a year. The market does all the work! Go ahead, take your kids to the park, relax, just check on the fund every great once in a while.

3) Never miss out on the Next Big Thing. Overtime, the index will adjust itself to account for new, up and coming companies. Read about CRISPR technology in the news? It’s very likely that CRISPR tech will pop up in your ETF sooner or later. Likewise, tech that fails to deliver on its promise will drop out of the index all on its own. Again, you don’t need to leave the beach.

Cons:

1) No home runs. As we will see, the ETFs have delivered rock solid returns over time, but ETF investors do miss out on the “lottery ticket” effect of a single stock that goes from $4 to $400 in three years. That just can’t happen when you own the whole market.

2) No growth in knowledge. You will never be more than a casual tourist in biotech land as long as you primarily own ETFs. When you go through the rigorous process of selecting individual stocks, and you know your cash is on the line, there is more than a slight chance that you will eventually learn what you are doing. If you choose the ETF route, you will always be “jack of all trades, master of none.”

3) No ability to double down. Let’s say that, as you invest in individual stocks, you learn about an emerging field like immunotherapy. Then you really start to believe in the long term progress of immunotherapy. If you invest in individual stocks, your portfolio can begin to reflect that belief. ETFs don’t work like that. No doubt the promise of IO is incorporated into today’s Biotech ETFs in a general way, but if this is indeed, The Cure for Cancer, you will largely miss out.

With all of these Pros and Cons in mind, let’s take a look at some of the more common biotech offerings available out there.

Winning!

Let’s remember that what defines a “biotech” from a simple pharmaceutical company is primarily size, culture, and scientific approach. Both Big Pharma and Biotech focus on making medicines for profit. Big Pharma tend to be much more established companies, with market capitalizations well into the billions. With the giant heft of Big Pharma comes a natural aversion to risk, a plodding pace of commercialization and development, and a tendency to grow through mergers and acquisitions, as opposed to true innovation. Biotech companies are typically brash, “pedal to the metal” outfits that will either discover something huge, or die trying.

If the second description gives you just a hint of nausea, stop now! You can happily invest in the Ishares US Pharmaceutical ETF (IHE). This basket of stocks represents the global heavy hitters of the pharmaceutical world. Despite an aversion to big risks, this cohort of established pharma firms has churned out a muscular 14.75% return over the last 10 year, easily beating the S&P 500 (11.52%). This ETF has achieved these impressive returns with less volatility than a typical biotech index, and also has an ample dividend payout from the steady cash flows that Big Pharma is famous for. IHE is a solid option for the more conservative investor. But if you have a thirst growth, and you can handle the inevitable highs and lows that come with innovation investing, then I would suggest you research the following four options.

1) S&P Biotech (XBI). This “bread and butter” biotech ETF is a who’s who of companies seeking to change the world through innovation. The underlying basket represents 125 different smallish companies, and the largest 10 holdings represent 18% of the total. The expense ratio is a modest .35% and the fund has returned an average of 17.25% annually over the last 10 years.

2) iShares Nasdaq Biotechnology Index (IBB). Although this ETF represents 191 different stocks, it is weighted in such as way that the top 10 names comprise roughly 50% of the total basket. The result is that the fund represents some of the relatively more established names in biotech, such as Amgen, Gilead, Celgene. You pay for that mix; the annual expenses are .46%. The fund has returned a potent 16.52% annualized over the last ten years.

3) First Trust NYSE Arca Biotechnology Index Fund (FBT). If you want to go “straight, no chase,” this ETF is a shot of pure innovation. The holdings are limited to just 30 companies on the cutting edge of science. This fund is relatively expensive, with a .56% annual fee, but so far, the payoff has been massive. The fund returned a shocking 20.86% annualized over the last ten years.

4) VanEck Vectors Biotech (BBH). If you want to bet on another hot tamale, this is it! This is another very concentrated fund; the basket represents only 25 of the most “liquid” names in biotech. This means that the underlying index represents the names that trade most frequently. If you want to invest in the names you hear on the news, this would be the way to do it. Apparently the strategy has worked so far; the fund has delivered a blistering 22.59% annualized return since it was founded in 2011.

When evaluating these options for your portfolio, please keep in mind that all reported returns are unusually good; this is because the 10 year annualized returns (a common measure of long term returns) began in 2008, when people were jumping out of windows on Wall Street. This means that we are measuring from a very low base. That being said, we can all do very well by doing good. Most of the funds above represent a sensible way to participate in the risk/reward equation that is modern scientific innovation. Millions of sick patients win as we relentlessly uncover new ways of attacking cancer, aids, and perhaps even old age itself. You win as your seedling companies grow into mighty oaks of science. What is a better deal than that?

2 Comments

  • What is your take on FBIOX?

  • FBIOX is an actively managed fund, not a passive ETF, so your expense ratio is a bit on the high side. That being said, according to the Fidelity website, $10,000 invested in the fund in 2008 would be $51, 071 today.

    Who would complain about that?

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$3,300,000,000,000,000. According to the Centers for Disease Control, that’s how much Americans will spend on healthcare this year.

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