Biotech ETFs Under The Microscope

By Gregory S. Davis | July 21, 2008 AAA

Even before Roche's offer to buy Genetech (NYSE:DNA) earlier this week, the biotechnology industry had performed well, especially since early June when the S&P 500 began a month-and-a-half long 11% decline.

Biotechnology exchange-traded funds (ETFs) like the SPDR S&P Biotech (AMEX:XBI), First Trust AMEX Biotechnology Index (AMEX:FBT), and Biotech HOLDRS (AMEX:BBH) have performed like a non-correlated asset group immune to the dreads of the overall market. Before choosing the fund with the hot hand of the day, it's important for investors to note how the composition of a fund can relate to its short term and long term performance results. In this article we'll explore the three biotech ETFs mentioned above, to show that what looks good today, may not be nearly as attractive a year from now. (For everything you need to know about this investment product, check out our Exchange-Traded Funds Feature.)

Near and Far
Since the beginning of the year:

  • Biotech HOLDRS (BBH) is up just over 18%.
  • The SPDR S&P Biotech (XBI) fund is up only 8%.
  • First Trust AMEX Biotechnology Index (FTB) is barely out of negative territory.

If we expand our time horizon out to three years, we find a different story:

  • BBH is just barely in positive territory.
  • XBI returned 46%.
  • FTB returned 24%.

What's Got Into BBH?
BBH is a more focused fund than the other ETFs mentioned with 60% of its holdings split between leading cancer drug maker Genetech and infectious disease fighter Gilead Sciences (Nasdaq:GILD). BBH has had a volatile three-year period only recently surpassing returns above those offered by the S&P 500. If you're bent on adding BBH to your portfolio you should also consider adding additional diversification in this space.

Best Bet - XBI's Diversity
XBI almost evenly allocates funds to its 24 biotech positions. Its top three holdings cancer drug maker Celgene (Nasdaq:CELG), cancer patient treatment provider ImClone Systems (Nasdaq:IMCL), and oral anticancer drug maker Onyx Pharmaceuticals (Nasdaq:ONXX) are popular among most of the Biotech ETFs, but XBI's even allocation sets it apart. Other well performing holdings year to date include Genetech and infectious disease fighter Vertex Pharmaceuticals (Nasdaq:VRTX). Be advised that the fund does have a relatively high turnover at rate 74%. (To better understand ETF holdings, read An Inside Look At ETF Construction.)

Runner Up - FTB
FBT is barely in positive territory since the beginning of the year but its investments in Vertex Pharmaceuticals, genetic variation decoder Illumnia (in route to personalized drug treatment), Genetech and Celegene have recently helped lift the fund out of negative territory since the beginning of the year. FBT holds only 20 stocks, but it also has a much lower turnover ratio of 11% and its investments are more evenly divided than the BBH fund.

Parting Thoughts
The list of diseases and aliments in need of a cure is long, giving biotechnology a prominent position in the minds of investors. Diversification is the key to building any successful portfolio. If you choose to concentrate in any one direction, try to find a complimentary investment to carry part of the load.

For further reading, see How To Use ETFs In Your Portfolio.

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