3 Pharma ETFs For Riding M&A Wave

April 29, 2014

But not all pharmaceutical exchange-traded funds are created equal.

What a difference a few weeks make. In late March, biotech stocks and related ETFs were reeling from a sell-off in momentum stocks as investors grappled with weak economic data in the U.S. and out of
China.

For example, the Market Vectors Pharmaceutical ETF (PPH | A-64), the iShares Dow Jones U.S. Pharmaceuticals ETF (IHE | A-64) and the SPDR S&P Pharmaceuticals ETF (XPH | A-38) were down 1.6, 4 and 7.2 percent from March 24 through April 7.

Fast-forward to the week of April 28 and the sector is humming to a different tune, thanks in large part to a trio of announced deals as well as new drugs hitting the market. Specifically, Pfizer has announced plans to buy AstraZeneca for close to $100 billion.

Also, GlaxoSmithKline last week announced that it will acquire Novartis AG’s global vaccines business for about $7 billion and sell its oncology business to Novartis for some $16 billion. Novartis is also in a deal agreement with Eli Lilly to sell its animal health business for approximately $5.4 billion in an all-cash deal.

“The two areas where I would expect to be more heavily involved in M&A are cancer and rare diseases because they’re hot areas within drug development these days,” said Steve Silver, a biotech equity analyst at S&P Capital IQ, in a previous interview with ETF.com.

PPH_Vs._IHE_Vs._XPH_Vs._SPY_YTD_performance

Chart courtesy of StockCharts.com

Additionally, Botox-maker Allergan Inc. confirmed that it has received an unsolicited proposal from Valeant Pharmaceuticals International and activist investor Bill Ackman to acquire all of the outstanding shares of the company.

On top of its deal with Allergan, Eli Lilly’s Cyramza drug, which is used to treat patients with advanced stomach cancer, has been approved by the U.S. Food and Drug Administration.

So despite the recent sell-off in biotech, PPH, IHE and XPH each gained upward of 6 percent last week on top of the M&A news. Novartis, Eli Lilly, Allergan and Pfizer are all prominent holdings in these ETFs. Year-to-date, XPH is up 6.8 percent, IHE is up 8.5 percent and PPH is up 13 percent, versus the S&P’s gain of 1.7 percent.

The Difference Maker

But why is there a disparity in returns between and XPH and PPH? The biggest factor impacting recent return dispersions between pharmaceutical ETFs is their weighting methodology, according to Spencer Bogart, an ETF.com analyst.

For example, PPH and IHE track a market-cap-weighted index of the largest global pharmaceutical firms and provide exposure to the largest multinational pharmaceutical giants in the world, such as Novartis and Pfizer.

However, IHE currently caps its exposure to these dominant names to 67.5 percent, with the remaining balance allocated to mid- and small-caps.

Meanwhile, XPH tracks an equal-weighted index of U.S. pharmaceutical companies, and offers equal-weighted exposure to roughly 30 U.S. pharmaceutical companies, making it far less concentrated than the industry, which is dominated by a handful of mega-cap names like Pfizer.

“XPH equal-weights its holdings, and this choice has a profound impact on their portfolios, which are less top-heavy as they tilt toward smaller companies,” said Bogart. “Of course, this says nothing about future performance; it simply means that equal-weighting methodology favors smaller firms at the expense of larger ones.”

 

Find your next ETF

Reset All