Biotech: Room to Run

04/21/2015 9:00 am EST

Focus: ETFs

Todd Rosenbluth

Senior Director of ETF & Mutual Fund Research, CFRA Research

Biotechnology has been one of the best performing industries in the stock market over the past several years, yet we think the industry's drivers, including a robust pipeline, remain intact and have a positive fundamental outlook, asserts Todd Rosenbluth, S&P Capital IQ Director of ETF Research in S&P's Marketscope.

Investors have increasingly utilized ETFs in a tactical manner to gain exposure to industries, while benefitting from the ability to make intra-day trades and benefit from their low-cost, passive nature.

iShares Nasdaq Biotechnology (IBB), First Trust NYSE Arca Biotechnology (FBT), and SPDR S&P Biotech (XBI)—the three largest, most direct ways to gain exposure to the biotech industry—experienced combined net inflows of more than $1.6 billion in 2014.

However, in the first two months, the trio had already added a collective $1.2 billion of inflows. While IBB and FBT primarily provide exposure to larger-cap biotechs, IBB is more concentrated. Top-10 assets comprised 56% of assets compared to 34% for FBT.

IBB is a market cap weighted ETF, meaning the largest companies, including Amgen (AMGN), Biogen (BIIB), Celgene (CELG), and Gilead (GILD) tend to dominate the portfolio.

S&P Capital IQ views all four of the stocks as undervalued on both a qualitative and quantitative basis, and not surprisingly, the ETF ranks favorably from both a STARS and Fair Value perspective.

Meanwhile, FBT holds just 30 stocks compared to 153 for IBB, but is equally weighted and rebalanced four times a year. Both of these ETFs also provide exposure to pharmaceutical and life sciences stocks.

Meanwhile, SPDR S&P Biotech holds just biotechnology stocks yet has more exposure to smaller-caps. Indeed, XBI's weighted average market cap was $8 billion, compared to IBB's $44 billion and FBT's $24 billion.

Like FBT, the ETF is equally weighted and rebalanced quarterly, but holds 88 stocks. Top-10 holdings comprised 17% of assets, including Intercept (ICPT) and Foundation Medicine (FMI).

In 2014, FBT climbed 48%, outperforming the otherwise impressive 45% and 34% for XBI and IBB, respectively. Year to date through March 25, SPDR S&P Biotech was the stronger performer of the trio. However, past performance is not necessarily indicative of future results.

We think SPDR S&P Biotech’s inclusion of smaller-caps contributed to its higher standard deviation relative to First Trust NYSE Arca Biotechnology and iShares Nasdaq Biotechnology. However, with a 0.35% expense ratio, SPDR S&P Biotech is the cheapest of the three.

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