Very few sectors have been able to avoid the sell-off in May. The strongest of the group has been the biotech stocks, which measured by the Dow Jones Biotechnology Index, is at an all-time high.

The combination of new drug approvals by the FDA and the speculation of more mergers have been the catalysts behind the recent outperformance. There is no reason to doubt that this action will end anytime soon. With that said, it is time to evaluate the biotech ETFs.

The iShares NASDAQ Biotechnology Index ETF (Nasdaq:IBB) is a basket of 118 biotech stocks that has over $1.8 billion in total assets. In 2012 alone, the ETF is up 21% and is at a new all-time high. Interestingly, it has a beta of 0.76 versus the S&P 500, contrary to the belief that the biotech sector is extremely volatile. The top ten holdings make up 54% of that allocation and the top holdings are Regeneron Pharmaceuticals (Nasdaq:REGN) and Amgen (Nasdaq:AMGN). Both stocks are trading near their best levels in years. The expense ratio is 0.48%.

The smaller SPDR S&P Biotech ETF (ARCA:XBI) has $576 million in total assets and is composed of 48 individual stocks. The ETF is up 25% in 2012 and is trading at a fresh all-time high. The top ten holdings make up 37% of the portfolio and the top two holdings are Human Genome Sciences (Nasdaq:HGSI) and Amylin Pharmaceuticals (Nasdaq:AMLN). HGSI is a recent takeover target and AMLN is up three-fold in the last six months. The expense ratio is 0.35%.

SEE: Mergers And Acquisitions: Understanding Takeovers.

The PowerShares Dynamic Biotechnology & Genome Portfolio ETF (ARCA:PBE) is not trading at an all-time high and is only up 9% in 2012. The ETF has a total of $133 million in assets. The portfolio of 30 stocks takes a slightly different approach with its selection process, by using price and earnings momentum. The top ten holdings make up 50% of the allocation and the top two holdings are Biogen Idec (Nasdaq:BIIB) and Gilead Sciences (Nasdaq:GILD). BIIB is trading at an all-time high and GILD has been strong recently. The expense ratio is 0.65%.

Selection Process
When it comes to choosing a biotech ETF, it is one of the most difficult decisions that sector investors will have to make. Historically, the three ETFs mentioned do not trade in unison and from year-to-year, the returns can vary greatly. This is due to the composition of the ETF, as the top two holdings of each ETF varies.

The Bottom Line
Everything from top holdings to fees are important when choosing the best biotech ETF for a portfolio. My current selection process points to XBI as the best of the group for investors looking to delve into the sector. The 0.35% expense ratio is the lowest of the group and the top ten only making up 37% is another positive. It seems that the best biotech ETFs also tend to be the most diversified.

SEE: Diversification: Protecting Portfolios From Mass Destruction.

Because the ETF is already up 25% in 2012 and trading at an all-time high, the best strategy is to wait for a normal pullback of a few percentage points and buy into the weakness. If you cannot wait, buy half a position now and the other half during a pullback.

Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!

At the time of writing, Matthew McCall did not own shares in any of the companies mentioned in this article.

Related Articles
  1. Chart Advisor

    Now Could Be The Time To Buy IPOs

    There has been lots of hype around the IPO market lately. We'll take a look at whether now is the time to buy.
  2. Stock Analysis

    Allstate: How Being Boring Earns it Billions (ALL)

    A summary of what Allstate Insurance sells and whom it sells it to including recent mergers and acquisitions that have helped boost its bottom line.
  3. Chart Advisor

    Copper Continues Its Descent

    Copper prices have been under pressure lately and based on these charts it doesn't seem that it will reverse any time soon.
  4. Options & Futures

    Cyclical Versus Non-Cyclical Stocks

    Investing during an economic downturn simply means changing your focus. Discover the benefits of defensive stocks.
  5. Mutual Funds & ETFs

    Buying Vanguard Mutual Funds Vs. ETFs

    Learn about the differences between Vanguard's mutual fund and ETF products, and discover which may be more appropriate for investors.
  6. Mutual Funds & ETFs

    ETFs Vs. Mutual Funds: Choosing For Your Retirement

    Learn about the difference between using mutual funds versus ETFs for retirement, including which investment strategies and goals are best served by each.
  7. Mutual Funds & ETFs

    How to Reinvest Dividends from ETFs

    Learn about reinvesting ETF dividends, including the benefits and drawbacks of dividend reinvestment plans (DRIPs) and manual reinvestment.
  8. Investing Basics

    How to Deduct Your Stock Losses

    Held onto a stock for too long? Selling at a loss is never ideal, but it is possible to minimize the damage. Here's how.
  9. Mutual Funds & ETFs

    Best 3 Vanguard Funds that Track the Top 500 Companies

    Discover the three Vanguard funds tracking the S&P 500 Index, and learn about the characteristics and historical statistics of these funds.
  10. Forex Fundamentals

    How to Buy Chinese Yuan

    Discover the different options that are available to investors who want to obtain exposure to the Chinese yuan, including ETFs and ETNs.
  1. Should mutual funds be subject to more regulation?

    Mutual funds, when compared to other types of pooled investments such as hedge funds, have very strict regulations. In fact, ... Read Full Answer >>
  2. Do ETFs pay capital gains?

    Exchange-traded funds (ETFs) can generate capital gains that are transferred to shareholders, typically once a year, triggering ... Read Full Answer >>
  3. How do real estate hedge funds work?

    A hedge fund is a type of investment vehicle and business structure that aggregates capital from multiple investors and invests ... Read Full Answer >>
  4. Are Vanguard ETFs commission-free?

    While some Vanguard exchange-traded funds (ETFs) are available commission-free from third-party brokers, a large portion ... Read Full Answer >>
  5. Do Vanguard ETFs require a minimum investment?

    Vanguard completely waives any U.S. dollar minimum amounts to buy its exchange-traded funds (ETFs), and the minimum ETF investment ... Read Full Answer >>
  6. Can mutual fund expense ratios be negative?

    Mutual fund expense ratios cannot be negative. An expense ratio is the sum total of all fees charged by an asset management ... Read Full Answer >>

You May Also Like

Trading Center