The iShares Nasdaq Biotechnology ETF (NASDAQ: IBB) was started in 2001 to track the performance of the Nasdaq Biotechnology Index, which consists of equities of biotechnology and pharmaceutical companies listed on the Nasdaq stock exchange. Since its inception, the fund demonstrated an average annual return of 9.65%. This exchange-traded fund (ETF) holds 150 biotechnology companies traded on the Nasdaq that have market capitalization in excess of $200 million.

The biotechnology sector demonstrated the largest five-year return of 34.05%, including capital appreciation and any dividends. However, such high returns come with a great risk, since there is a lot of uncertainty surrounding the medical research and there is a high failure rate in this sector.

Due to the aging population worldwide and appearance of new and hard-to-cure diseases, the demand for new drugs and innovative treatments is poised to continue growing. The iShares Nasdaq Biotechnology ETF was created to take advantage of the abnormal returns generated by biotechnology companies.

The fund uses a representative sampling indexing strategy to have an investment profile similar to the underlying index. IBB invests at least 90% of its $9.6 billion of assets in equities and depositary receipts to obtain similar exposure of the Nasdaq Biotechnology Index. As of July 2015, the fund invested 97% of its funds in the U.S. stocks and allocated 62% of its holdings to large-market cap biotechnology companies, 17% to medium-cap companies and 19% of its holdings to small- and micro-cap firms.

The top five companies held by the iShares Nasdaq Biotechnology ETF are Celgene (CELG), Gilead Sciences (GILD), Amgen (AMGN), Biogen (BIIB) and Regeneron Pharmaceuticals (REGN). In aggregate, the top five holdings account for about 40% of the fund's portfolio. IBB also invested in less-known and very risky biotechnology companies, such as Anacor Pharmaceuticals (ANAC), Horizon Pharma (HZNP) and Intercept Pharmaceuticals (ICPT), which generated the biggest payoff for the fund.

Characteristics

IBB is managed by BlackRock Fund Advisors and follows a passive investment strategy by seeking to mimic the performance of the underlying index. The fund does not change its positions to benefit from the market swings. For this reason, the ETF's turnover ratio of 33% is relatively low compared to ETFs in a similar class, resulting in an expense ratio of 0.48%.
IBB can be purchased like any other stock on New York Stock Exchange, and certain brokers offer IBB commission-free.

Suitability and Recommendations

Investing in the iShares Nasdaq Biotechnology ETF comes with the risk of investing in biotechnology sector. Biotechnology companies conduct extensive research and development, which may not prove financially viable on the market. By the time the drug reaches the intended market, it may no longer be considered efficient or the best in its category. Investors should be familiar with current and expected trends in the biotechnology sector before purchasing this ETF.

The ETF invests about 20% of its assets into small-cap companies that tend to have a high rate of failure in achieving their milestones and commercializing their products due to loss of intellectual property rights, failure to pass regulatory hurdles and inability to raise sufficient resources to fund their projects. Because the fund allocated one-fifth of its holdings to these small companies with high-risk/high-reward proposition, it can be considered relatively diversified from the potential downside coming from small biotechnology companies.

IBB has a five-year R-squared ratio of 0.28 and beta of 0.67 in relation to the MSCI ACWI (USD) Index. The fund also demonstrated a superior returns compared to the MSCI ACWI (USD) index by generating alpha of 25.08. Yet, the fund had a five-year standard deviation of 17.3% compared to the standard deviation of 13.6% for the MSCI ACWI (USD) index.

From the perspective of the modern portfolio theory, this ETF is most suitable for following a growth strategy after considering relevant risks. IBB is most suitable for investors looking to obtain exposure to the U.S. biotechnology companies with positive prospects that come with significant downside risks. IBB represents a low-cost way to gain exposure to the sector with diversification against single-stock risk and is most appropriate for investors interested in receiving as much diversification as possible in the biotechnology sector.

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