What Is a Pharmaceutical ETF? Everything You Need to Know

Investors may choose to invest in pharmaceutical ETFs for various reasons, including seeking exposure to the pharmaceutical sector's potential for growth, diversification of their investment portfolio, or aligning their investments with their belief in the long-term sustainability of the pharmaceutical industry. 

What Is a Pharmaceutical ETF?

Also known as a pharma ETF, a pharmaceutical ETF is an exchange-traded fund that focuses specifically on tracking the performance of companies within the pharmaceutical industry of the broader healthcare sector. Pharma encompasses companies involved in the research, development, manufacturing, and distribution of pharmaceutical drugs and related healthcare products.  

Pharmaceutical companies, such as Pfizer Inc. (PFE), Johnson & Johnson (JNJ) and Eli Lilly and Company (LLY), are typically engaged in the discovery and commercialization of medications, vaccines, and other therapeutic treatments. 

Benefits and Risks of Pharmaceutical ETFs 

Pharmaceutical ETFs offer several benefits, including diversification, access to a range of companies and the potential for long-term growth. However, like any investment, pharmaceutical ETFs come with risks that investors should understand before buying shares. 

Benefits of Investing in Pharma ETFs 

• Diversification: Pharmaceutical ETFs invest in a basket of companies within the pharmaceutical industry. This provides investors with exposure to a wide range of companies, reducing the risk of any single company impacting the performance of the portfolio. Diversification is a key component of a well-rounded investment strategy, and ETFs offer an easy and efficient way to achieve it. 
• Access to a range of companies: Investing in a pharmaceutical ETF gives investors access to a broad range of companies, including large cap big pharma companies, mid-cap biotech firms and small cap drug development companies. This provides exposure to the full spectrum of the pharmaceutical industry, from established players with stable earnings to high-growth companies developing cutting-edge treatments. 
• Potential for long-term Growth: The pharmaceutical industry is expected to continue to grow as the global population ages and demand for health care services increases. This presents a long-term growth opportunity for investors who are willing to hold their investments for several years. 

Risks of Investing in Pharma ETFs 

• Regulatory risk: The pharmaceutical industry is heavily regulated, and changes in regulations can impact the performance of pharmaceutical ETFs. For example, if a regulatory agency rejects a drug application, it could significantly impact the stock price of the company that developed the drug, as well as the ETF that holds that company's stock. 
• Clinical trial risk: Investing in pharmaceutical ETFs comes with the risk that clinical trials may not produce the desired results. If a company's drug does not meet its primary endpoint in a clinical trial, it could result in a significant decline in the stock price, and subsequently, the ETF's performance. 
• Patent cliff risk: The pharmaceutical industry is subject to the risk of the "patent cliff," which occurs when a company's patent on a profitable drug expires, allowing generic competitors to enter the market. This can significantly impact the company's revenue and, as a result, the ETF's performance. 
• Concentration risk: While pharmaceutical ETFs offer diversification, they are still subject to concentration risk. This means that if the ETF holds a significant amount of shares in a single company or a small number of companies, it could significantly impact the ETF's performance if that company or companies experience significant changes in stock price. 

Largest Pharmaceutical ETFs by AUM

Data as of September 20, 2023.

Bottom Line on Investing in Pharma ETFs

Pharma ETFs offer investors a way to gain exposure to the pharmaceutical industry, diversify their portfolio, and potentially benefit from long-term growth. However, investing in pharma ETFs comes with risks, including regulatory, clinical trial, patent cliff, and concentration risks.  

As with any investment, investors should carefully consider the potential benefits and risks of pharma ETFs before buying shares.