Biotech ETFs Back In The Spotlight

Biotech ETFs such as the iShares Nasdaq Biotechnology ETF (IBB) were trying to stage a recovery from two-plus-year lows earlier this year when a controversy involving Mylan and its decision to hike the price for EpiPens brought the segment’s rally to a screeching halt in the past week.

Mylan’s move to increase the price of its Epinephrine injections (the widely used EpiPens) to about $600 each (they cost about $100 in 2008, according to Reuters) triggered the fury of consumers and investors alike. The result was a sell-off in the biotech segment that sent IBB, the largest biotech ETF, down more than 4.3% in just five days.

The drop was twice as steep as the one faced by the broader health care sector, and four times as deep as the S&P 500 in the same period. The latest blow highlights just how far biotech has departed from the stellar performance we had seen from the health-care-leading segment in the past five years.

“We look at price trend,” Steve Blumenthal, chairman and chief executive officer of CMG Capital Management, said. “It is lagging this year. Biotech is much more volatile than most sectors—it’s just the nature of the asset class.”

Consider the chart below, which plots IBB’s five-year performance relative to the Health Care Select Sector SPDR (XLV) and the broader SPDR S&P 500 (SPY). The outsized gains are noteworthy: 

Biotech A Momentum Play

This week’s volatile plunge following Mylan’s action—one that elicited even commentary from presidential hopeful Hillary Clinton—is also a good reminder that biotech is a classic momentum trade.

Momentum stocks are those that have delivered strong relative performance in the recent past, and are likely to continue delivering strong gains in the near future. They are often high-risk investments, because at their core, momentum hinges on perfect timing. But as a factor, momentum doesn’t always outperform. No single factor ever does.

Chris Brightman, CIO of Research Affiliates, best described momentum investing in a recent piece, saying:

“Momentum investors are like the surfers we watch from beaches along the Pacific Coast. Both must catch a wave. Both attempt to ride it as it breaks. But the ability to glide away smoothly before being caught inside the inevitable crash(ing wave) that follows is what determines success.”

Biotech companies delivered investors an amazing wave in the past five years, shelling out 100 percentage points more in total returns than an investment in SPY, but these stocks, too, can correct, and dramatically at times.

Like any other high-risk play, investing in biotech companies—those at the edge of innovation and discovery—isn’t for investors afraid of a wild ride.

So far in 2016, the momentum trade has, by and large, underperformed the S&P 500 Index, as shown in the chart below through the performance of the iShares Edge MSCI USA Momentum Factor ETF (MTUM). Biotech has deeply underperformed on top of that. MTUM allocates about 16.2% to health care names. 

Plenty To Choose From

Biotech ETFs may offer a wild ride, but they also offered plenty of diversity. No two funds are alike in this segment.

Our segment report details these differences and points out that biotech ETFs offer such different exposures relative to one another, that “costs and liquidity are secondary issues” when choosing the right fund for you. A look at the top three, as measured by total assets, is a great example of that.

IBB, the largest and most popular biotech ETF in the market today, with $7.3 billion in total assets, only invests in companies that are listed on the Nasdaq. No matter how attractive, cutting-edge or crucial to the segment a company may be, if it’s not listed on the Nasdaq, it doesn’t make into IBB.

Still, that selection criteria is hardly a limiting factor for the size of the portfolio. IBB has the largest biotech portfolio, with roughly 190 holdings.

The fund offers not only broad exposure, but also a plain-vanilla approach to the segment, weighting its securities by market capitalization. In other words, IBB is a pretty concentrated on the larger-cap names. Mylan is the fund’s eighth-largest holding, at about 4% of the mix.

Pure-Play Biotech ETF

Consider the second largest biotech ETF, the SPDR S&P Biotech ETF (XBI), with $2.2 billion in total assets.

XBI strives to be the pure-play option in this segment by bypassing a lot of pharmaceutical names in search of the true biotech companies. XBI also equal-weights its 80-or-so holdings.

The third-largest, the First Trust NYSE Arca Biotechnology Index Fund (FBT), with nearly $1 billion in assets, owns only 30 stocks. Only 30.

Among them are pharmaceuticals and medical technology names as well as biotech firms. The fund, too, is equal-weighted, which means it offers investors a tilt toward smaller-cap companies.

Similar Performance Trajectory

These portfolio differences are evident in the funds’ returns, even though they all follow a similar performance trajectory, as the chart below shows. IBB is the weakest performer of the top three so far in 2016:

Charts courtesy of StockCharts.com

Opinion is divided on whether biotech is going to resume its upward rally and continue to retrace some of the correction it has staged in the past few months. News of mergers and acquisitions—deals such as Pfizer buying Medivation for $14 billion—and expectations of new drug breakthroughs have some analysts looking for gains ahead.

And others, such as Blumenthal, point out the fact that, relative to equities, biotech “has tanked” since last summer, but the segment is just “making a natural retracement that is magnified compared with more docile sectors. Still, the recent performance is “normal,” relative to its own past price action, he says.

But investors looking to own a piece of this action need to brace for the ups and downs that come with a high-risk play, and look closely under the hood to pick the ETF that best corresponds to their views on the segment. 

Contact Cinthia Murphy at [email protected].