Van Eck entered the fray in December, 2011 with an approach it believes differentiates itself in this increasingly crowded ETF niche. “We wanted to focus on the industry leaders, and also sought to price it with a low expense ratio (of just 0.35%)” says Brandon Rakszawski, product manager at Market Vector ETFs.
The Market Vectors Biotech ETF (BBH) owns the industry’s blue chips and eschews any companies that have yet to build a broad-based drug portfolio. The recent top five holdings—Amgen (AGMN), Gilead Sciences (GILD), Biogen Idec (BIIB), Celgene (CELG), and Regeneron Pharma (RGEN)—have a collective market value exceeding $200 billion. The fund got off to a roaring start by rising more than 47% in its first year of existence, plus another 6% so far in 2013.
The iShares Nasdaq Biotechnology (IBB) is the most popular ETF in the sector, with more than $2 billion in assets under management and more than 500,000 shares traded daily. The ETF takes a highly diversified approach, holding more than 100 stocks from the Nasdaq biotech index. Each holding has a market value of at least $200 million. Roughly one-fifth of the portfolio is dedicated to early-stage developing biotechs, which helps to capture upside when the sector’s off-the-radar upstarts strike gold with either an FDA approval or a buyout.
Still, nearly three-fourths of the fund is earmarked towards mid-sized and large biotechs, which helped this portfolio in 2008 when the market was tumbling. The ETF slipped just 12% that year, and has risen at a double-digit clip in subsequent years, leading to an 11% annualized gain over the past five years. The 0.48% expense ratio is in the middle of the pack. Like with the first two funds, IBB was up 6% this year as of Friday.
Merrill Lynch’s McMinn notes that smaller biotech firms failed to participate in the broader industry rally in 2012, and they now sport lower valuations as a group. She’s a bit cautious on further gains for the industry’s big players, and spots a rotation coming. “As we look to 2013, we see some pressures on multiples in more expensive growth stocks and potential for multiple expansion in cheaper stocks with improved pipeline visibility,” she wrote in her report.
If she’s right, then ETF investors may want to focus on the SPDR Series Trust S&P Biotech ETF (XBI), which according to Morningstar provides much more exposure to small- and mid-cap stocks than other ETFs. But Morningstar also cautions that despite the fund’s diversification, roughly half of it's holdings are early-stage players with no marketable drugs. Despite the increased emphasis on smaller, riskier biotechs, this fund has still managed to deliver an impressive 19% annual gain over the past three years. XBI has jumped out to an impressive 8% gain in early 2013. The 0.35% expense ratio is also among the lowest in the sector.
Biotechs staged a strong run in 2012, but there’s no reason to expect a sudden reversal of fortune. The factors that have driven recent gains remain in place, although a shift in relative outperformance to smaller biotechs appears likely.
David Sterman has worked as an investment analyst for nearly two decades. He was a senior analyst covering European banks at Smith Barney and was research director for Jesup & Lamont Securities. He also served as managing editor at TheStreet.com and research director at Individual Investor magazine.