While biotechnology stocks and exchange traded funds continue frustrating market participants in the early innings of 2022, investors should not lose sight of the fact this corner of the healthcare sector offers ample exposure to innovation.

Among the related ETFs, the ALPS Medical Breakthroughs ETF (SBIO) is one to consider for investors seeking a line-up full of companies with significant innovative potential. That’s a relevant point for investors to consider over the near term as more healthcare companies ramp up research and development efforts.

“The global pharmaceutical and biotechnology sector is increasing its focus on research and development (R&D) productivity as innovation has become a key driver of growth,” Fitch Ratings says in a recent note.

SBIO takes the R&D part of the biotech investing equation seriously. The S-Network Medical Breakthroughs Index — SBIO’s underlying benchmark — requires that member firms have at least one drug or therapy in a Phase 2 or Phase 3 clinical trial. Not only does that reduce some of the risk associated with smaller biotech companies, it indicates that some SBIO components have the potential to eventually bring breakthrough drugs to market.

“Innovations support revenue and cashflow growth in the sector, but pharmaceutical R&D processes have become longer and specialised with extensive clinical trials required, making them more expensive. Market participants are seeking to increase R&D productivity by being more focused in their research, hoping to achieve greater synergies in the regulatory approval process,” adds Fitch.

Adding to the allure of SBIO for patient investors are two factors. First, the ETF’s index requires that companies have enough cash to support themselves for two years at current burn rates, which is meaningful because healthcare R&D is expensive.

Second, SBIO, in its more than seven years on the market, has often been an epicenter of biotechnology mergers and acquisitions activity. Whether that proves meaningful this year remains to be seen, but large-cap pharmaceutical companies are sitting on ample amounts of cash and need to bolster their pipelines.

“Fitch expects greater specialisation of business models to continue focusing on three pillars – innovative pharmaceuticals, generic pharmaceuticals and consumer health – in addition to active portfolio management within divisions. The latter includes targeted M&As, partnerships and life-cycle management of existing drugs and brands, such as divestments of tail-end products to free resources. Larger M&As are also possible in the long term,” concludes the research firm.

Other biotech ETFs to consider include the VanEck Vectors Biotech ETF (BBH), the iShares Biotechnology ETF (IBB), and the Virtus LifeSci Biotech Clinical Trials ETF (BBC).

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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.