Biotech ETFs Break Out

January 19th at 9:45am by John Spence

The rally in biotechnology exchange traded funds is going vertical in early 2012 with the sector’s largest ETF posting a gain of 20% over the past three months.

The $1.5 billion iShares Nasdaq Biotechnology Index Fund (IBB) is breaking out to new all-time highs. The ETF is up 9.6% year to date, compared with a 4.1% gain for the S&P 500, according to Morningstar.

Top portfolio holdings include Amgen (AMGN), Celgene (CELG), Gilead (GILD) and Biogen (BIIB).

“The upside here is that large pharmas will continue to acquire these companies so long as their own R&D departments are starving.  They have tons of cash and a burning desire to add pipeline — which makes almost every publicly-traded biotech a target for someone,” writes Josh Brown at The Reformed Broker.

He notes the biotech ETF has a “very concentrated portfolio” with more than 50% of assets in the top 10 holdings. “This is all very bullish action but investors with a weak risk tolerance need to be careful of course — this ain’t your daddy’s healthcare index fund,” Brown said.

Still, the ETF allows investors to buy a basket of biotech companies and reduce the risk of a single stock blowing up.

“Investors seeking exposure to the highly uncertain but potentially promising prospects of the biotech industry can consider adding iShares Nasdaq Biotechnology to their portfolios as a tactical satellite position to a diversified equity portfolio,” writes Morningstar analyst Robert Goldsborough in a profile of the ETF.

Almost 25% of assets are small-cap names applying innovative techniques to research, develop, and commercialize various drugs targeting certain diseases or therapeutic niches, he added.

“The jarring pace of change, single-product liability, regulatory uncertainties, and intellectual property rights make picking stocks in the biotech sector a high-risk/high-reward proposition,” Goldsborough said. “As such, we think investing in the industry via an ETF makes a lot of sense; it’s an extremely low-cost way to gain diverse exposure to the industry in one trade.”

The sector fund has an expense ratio of 0.48%. Other ETFs in the category include SPDR S&P Biotech ETF (XBI), First Trust Amex Biotechnology (FBT) and Market Vectors Biotech ETF (BBH).

The rally in biotech stocks may also be driven by expectations that President Barack Obama’s health care reform plan may be repealed, according to Gunderson Capital Management.

“Since health-care costs are outpacing consumer inflation, government and industry will be seeking myriad ways to cut costs. This means an even greater reliance upon drugs, particularly generics,” Reuters reported in a 2012 outlook. “Patents on brand-name drugs are scheduled to expire in coming years, potentially creating a $100 billion market for generics. Sectors likely to benefit are pharmaceuticals, biotechnology, distributors and drug retailers.”

iShares Nasdaq Biotechnology Index Fund

Full disclosure: Tom Lydon’s clients own XBI.

The opinions and forecasts expressed herein are solely those of John Spence, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.