Biotech ETFs are among this year’s highest flyers, but will the party end in a bad bubble?
Four biotechnology-focused ETFs were among the top-10-performing ETFs in the first half of 2012, as the research-driven entrepreneurial slice of the health care industry outperformed the rest of a sector that many have been betting would shine brightly anyway.
The demographic backdrop of aging populations around the developed world, plus the prospect of “Obamacare” delivering upward of 30 million new patients, has helped fuel health care equities. Add to that the mergers and acquisitions potential that many successful biotech companies present as their latest cures catch the attention of “big pharma,” and you have the recipe for rocketing returns.
The First Trust NYSE Arca Biotechnology fund (NYSEArca: FBT) outperformed all the other biotechs in the first six months of 2012, rising in value by more than a third, making it the second-best-performing U.S.-listed ETF behind the construction ETF “ITB,” which we wrote about separately. Since the end of the quarter, FBT has tacked on more gains, and is now up more than 37 percent for the whole year.
“Biotech is a high-beta play in the health care space,” said Paul Weisbruch, an ETF trader at King of Prussia, Pa.-based Street One Financial.
“There’s a lot of M&A activity going on in biotech,” he added, noting the small hole-in-the-wall labs that come up with promising pharmaceuticals are huge growth opportunities for big drug companies looking to replenish their product pipelines.
Look more closely at FBT and another biotech ETF right behind it that was the third-best performer in the first half, and things get more interesting.
Both FBT and the SPDR S&P Biotech ETF (NYSEArca: XBI)—which returned 33.24 percent in the first half—use equal-weighted indexing strategies.
Equal-weighted funds invariably allocate more of their portfolios to smaller companies and that, in turn, means funds with higher-risk/higher-return profiles.
So, it’s no surprise that right now, high-beta funds like FBT and XBI are flying high. For the record, FBT has a beta of 1.22 and XBI has a beta of 1.25, according to IndexUniverse ETF Analyst Dennis Hudachek. That essentially means they are going to move more than the market.
That, of course, works both ways, so high-beta funds such as FBT and XBI are likely to fall the hardest when that day comes.