New Market Realities Require More Diversity, Not Less

January 20, 2009

Changing trends in currencies, agriculture and biotech demand more awareness of emerging asset classes and industries in building portfolios. 

 

With the S&P 500 down close to 5.8% and the MSCI EAFE Index bleeding some 9.6% so far in 2009, investors enter a new year understandably wary of investing in traditional stock exchange-traded funds.

But just think about younger investors. We're seeing a whole generation come of age in terms of investing, just six years removed from the nasty bear market of 2000-2002 and last year's seeming fiasco. Is there little doubt that many are seriously questioning the long-term benefits of putting together an old-school portfolio of just stocks and bonds?

As we've been trying to tell investors in this column over the past year, traditional methods of building diversified investment plans can omit important asset classes and funds. The world is changing rapidly and now's not the time to punt. Rather, this is a good time to reexamine your strategy and make sure it's all-inclusive and up-to-date to meet today's changing economic order.

A good example of that comes by considering what's taking place with biotech stocks. Just a few years ago, most of these companies didn't offer much in the way of profits or diversity in product lines. But these days, big biotechs have more dynamic pipelines for new products than most established pharmas. Take a look at Amgen—it now has about the same market cap as Merck & Co.

An exchange-traded fund we're using to provide added exposure to the sector is the SPDR S&P Biotech (NYSE: XBI). It was down 0.63% heading into Tuesday. More importantly, last year it returned -8.8%, nearly 30 percentage points better than the broader market.

This particular ETF is fairly equal weighted. That's different than most other biotech ETFs with huge overweights to a few big names. Traditional market-cap sizing in such a specialized field tends to add a lot of volatility to a portfolio. In sharp contrast, XBI's cap weightings are very evenly spread between large-, mid- and small-cap stocks.

By contrast, look at the iShares NASDAQ Biotechnology Index (Nasdaq: IBB). It's also slightly down this year after losing close to 12% in 2008. That's still pretty good compared to the S&P 500. But again, look at its portfolio's makeup. Two names—Amgen and Gilead Sciences—represent almost a quarter of its total holdings. Another 20% or so come from four big companies.

Biotech is often associated with the Tech sector. But hardware and software firms are dependent on changing short-term demand cycles. Compare the Technology Select Sector SPDR (NYSE: XLK), however, to XBI. You can see performance between the two has been less correlated, as biotech matures and fundamental drivers behind biotech become more sophisticated.

And in the short term, biotech figures to further diversify its business as a new administration in the White House should be more friendly to a new age in medical research and product development.

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