Strong prospects for new drug approvals, a favorable M&A environment, and a positive fundamental outlook have the biotechnology industry looking healthy, according to S&P Capital IQ. Investors who want exposure to the overall sector should consider exchange traded funds to help mitigate single-stock risks.

The biotech sector is known for volatility — big risks and rewards. For example, the Nasdaq Biotechnology Index rose 457% from the end of August 1998 to the end of February 2000, writes Don Miller at Money Morning.

“The good news for investors is that after slumping during the recession, biotech stocks are making a comeback. In the first quarter of 2012 alone, the Nasdaq Biotech Index gained 18.2%. And conditions are setting up for even better gains in the future,” Miller wrote, adding that big pharma companies are losing patents on blockbuster drugs.

“While many biotech companies are riding high on new drugs, the recent surge in biotech stocks largely reflects a slew of mergers and acquisitions,” he said. “More importantly, more deals are likely on the horizon.”

“In 2011, the U.S. FDA approved 30 new drugs, compared to 21 in 2010. We see an improving trend for FDA first cycle approvals and a rise in the rate of new drug approvals for rare diseases. We think these trends are helping to boost investor sentiment toward the agency, after years of criticism stemming from its inconsistency in making and communicating its decisions,” adds Steven Silver, S&P Capital IQ Analyst, in a recent note. [Biotech ETFs Weather the Market Storm]

In the view of S&P Capital IQ, biotechnology carries the potential for above-average performance, but with a high inherent risk profile. The following ETFs can help mitigate risk by investing in several companies, rather than banking capital on just one.

SPDR S&P Biotech ETF (NYSEArca: XBI) has had a total return of 9.56% over the past 12 months ended April 30.Other ETFs to consider are the PowerShares Dynamic Pharmaceuticals (NYSEArca: PJP) which has a 12-month return of 18%. The iShares Nasdaq Biotechnology Index Fund (NYSEArca: IBB) has returned 14.8% over the past 12 months, according to S&P Capital IQ. [Choosing the Right Biotech ETF Exposure]

Furthermore, the positive environment for merger and acquisition activity in the biotech sector is only going to help the performance. Larger, billion dollar companies will become more active as the “patent cliff” has caused large players to lose patents due to expiration. [5 Biotech ETFS to Play Innovation]

An emerging FDA infrastructure will likely oversee “biosimilar” drug approvals, which gives a 12-month branding period to drugmakers, however, these may not hit the market for several years. Partnering activity between biotech and generics could become more common. [Biotech ETFs Break Out]

SPDR S&P Biotech ETF

Tisha Guerrero contributed to this article.

The opinions and forecasts expressed herein are solely those of Tom Lydon, 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.

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