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.

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.

Tickers in this Article: IBB, XBI, PBE, AMGN, BIIB

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