Medical Miracles Inside Biotech ETFs

The events of the past twelve months focused a lot of attention on amazing and life-altering developments made possible by the global biotech industry.  Although the major names we heard were Pfizer(PFE), AstraZeneca (AZN), Johnson & Johnson (JNJ) and Moderna (MRNA), only the last was where the original research and patents that produced the COVID-19 vaccines were developed.  Pfizer partnered with a German company called BioNTech (BNTX) while the other two pharmaceutical giants acquired firms with patents in genetically modified vaccines.  Not that coronavirus vaccine research and clinical trials were happening in a vacuum.  For example, among the clinical trials leading to FDA approval were two drugs shown to stop the spread of specific types of brain cancer. The original research and patents also originated at small biotech companies. 

Vaccine, Cure, Medicine, Virus, Covid-19

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Investing in biotech requires an understanding of the industry.  Its general composition includes a few giants such as Amgen and Biogen. That said, the true growth of investments in small cap companies that use unconventional techniques to develop potential cures. Many are one-, two- or three-patent companies that will either get approval for a very successful drug and either attract a lot of capital or get acquired by a large pharmaceutical company. Individually, these stocks are high-risk / high-return situations.   Think of when Inclone collapsed resulting the Martha Stewart mess.  There is far more safety and improved expected return per unit risk ratios with diversified portfolios of the stocks of Biotech companies.  Biotech ETFs, particularly indexed biotech ETFs, provide means of doing just that.

This article takes you inside four Biotech ETFs:

1. ALPS Medical Breakthrough ETF (SBIO)

2. First Trust NYSE Arca Biotechnology Index Fund (FBT)

3. iShares Nasdaq Biotechnology ETF (IBB)

4. SPDR S&P Biotech ETF (XBI)

Amazingly, all four ETFs are rated 5, our top rating, by the ValuEngine model.  This is a distinction held by just a handful of other ETFs.  The returns are also fairly highly correlated.  That said, there are many important differences among them.

These ETFs follow significantly different indices constructed from quite different selection universe.  Two of them, somewhat counterintuitively, confine themselves to stocks traded on a single exchange.  First Trust’s FBT, the oldest, only selects biotech stocks with their primary listings on NYSE Arca.  There is a legacy reason for this as the ETF was originally listed on the American Stock Exchange, the pioneer of ETF listings. When NYSE Arca eventually acquired that exchange, they took over the ETF business and any exchanged-based indexes were switched over to NYSE Arca.  FBT also limits itself to 30 equally weighted stocks meeting its classification criteria for the biotech subindustry. IBB from iShares follows a cap-weighted Nasdaq index that meet the subindustry classification criteria. The fund’s selection disciplines result in much larger portfolios than FBT, currently 128 stocks   However, its choice of a market-cap weighted index works against fund holding diversification as its top 5 holdings account for nearly a quarter of the fund. Despite my generalized exceptions to portfolios based upon selection universes limited by exchange of listing.  Ten-year holders of IBB and FBT have fared better than most as both have realized a greater 10-year annualized return than (VOO), Vanguard’s S&P 500 ETF.

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Disclosure: I am considering taking positions in XBI after constructing this analysis.

Disclaimer: Always read the fact sheets and/or summary prospectus before buying any ETF.  Past ...

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