ETF Trends
ETF Trends

The biotechnology sector and related exchange traded funds are breaking out to new highs, but the rapid ascension has some worried about valuations.

The iShares Nasdaq Biotechnology ETF (NasdaqGS: IBB), the largest biotech ETF by assets, has surged 27.9% year-to-date while the S&P 500 index has only gained 3.6%.

However, given the lofty year-to-year returns, some are growing cautious over the biotech sector.

“We’ve got a bit of a dotcom scenario going on in biotech,” James Paulsen, chief investment strategist at Wells Capital Management, told the Financial Times.

According to Markit, U.S. pharmaceutical, biotech and healthcare services are now the most shorted sector in the Russell 3000, overtaking the energy sector in April.

Some argue that the high valuations in the biotech sector have been supported by a low interest rate environment. However, with the Federal Reserve eying an interest rate hike, biotechs may be more vulnerable ahead.

“Some of the things that have boosted the biotech sector are likely to disappoint in the next few years,” Brad Sorensen, director of sector research at Charles Schwab, said in the FT article. “We are warning investors that the biotech sector does have toppy tendencies. It does seem overvalued at this point.”

Additionally, Emmanuel Cau, global equity strategist at JPMorgan, warned that merger and acquisition activity, which has also added to biotech momentum, is sensitive to Fed tightening. Sorensen also cautioned that new drugs don’t always get approved and M&A won’t last forever.

Despite concerns that biotech stocks remain excessively valued and vulnerable to sharp pullbacks, traders are embracing leveraged biotech ETFs at a decent clip. For instance, in the three weeks ending July 13, traders added nearly $27 million to ProShares Ultra Nasdaq Biotechnology (NasdaqGM: BIB), which attempts to deliver twice the daily returns of the NASDAQ Biotechnology Index. [Traders Bet on new Leveraged Biotech ETFs]

On the other hand, investors who are wary of a potential biotech pullback can utilize a few inverse or bearish ETF options to hedge their positions. For instance, the recently launched Direxion Daily S&P Biotech Bear Shares (NYSEArca: LABD) takes the -3x or -300% daily performance of the biotech sector, ProShares UltraPro Short NASDAQ Biotechnology (NasdaqGM: ZBIO) tracks the -3x or -300% daily performance of the Nasdaq Biotechnology Index, ProShares Ultrashort Nasdaq Biotechnology (NasdaqGM: BIS) tracks the -2x or -200% daily performance of the biotech space and ProShares UltraShort Health Care (NYSEArca: RXD) follows the -2x or -200% daily performance of the broader healthcare sector.

For more information on the biotech sector, visit our biotechnology category.

Max Chen 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.