Biotech Bull Market: Are ETFs Better Than Mutual Funds?

Biotech ETF’s Slightly Outperform Life Science Mutual Funds

There has been an ongoing debate in the media on the performance of ETFs compared to actively managed funds so we have compared the performance in a hot sector like biotech which is entering its 5th year of a bull market. The NYSE Arca Biotech Index is up 33.7% over one year and 19% on a three year annualized basis. The NASDAQ Biotechnology Index (NBI) is up 78% over 5 years or 15.6% annualized. In a 5/27/2011 article I wrote in Investor Uprising, “Guide to Biotechnology Investing”, we recommended ETFs as a way to balance healthcare stock portfolios.

Four major ETFs were reviewed on 5/6/11 and compared to three of the best performing mutual funds:

Top Biotech Mutual Funds
Symbol	Price	Value $B	1 Yr. Return	5 Yr. Return	5 Yr. (annualized)
PRHSX	35.60	2.8	37.72%	40.6%	10.4%
FBIOX	84.58	1.23	29.75%	35.75%	6%
SHSAX	31.95	1.43	17%	29.8%	9.56%

 

Most Liquid ETFs Vs. QQQ
Symbol	Price 5/6/11	Net Assets ($B)	52-week Range	1 yr. Return	5 yr. Return	XTF.comRating*
FBT	44.26	0.218	29.40-45.50	39.5	122	5.1
IBB	106.49	1.63	74.50-109.61	28.9	36.5	7.1
XBI	72.29	0.471	47-75.17	35	51	6.4
QQQ	58.47	49.1	41.77-59.3	28.75	38.7	8.6
* 10 is best

As of 1/15/13 the Biotechnology sector is up about 8% YTD continuing the impressive run of 2012. The sector is near or slightly above the 2012 high mark with a bit of frothiness in evidence. What we see is that momentum begets momentum because more than any other sector biotechnology is driven by sentiment and less by fundamentals and macro events.

Let’s compare the returns over 5 years and one year for two of the larger ETFs IBB ($118.70) and XBI ($97) with the largest fund the Five Star Morningstar, Fidelity Select Biotechnology (FBIOX $118.7):

• The IBB is up 75.8%,  one year 30%. $2.15B in assets.
• The XBI is up 58.2%,  one year 31.4%. $692M in assets.
• The Fidelity (FBIOX) Fund is up 72.3%,  one year 26.85% as of Dec 3o 2012. $2.73B in assets.

The expense ratio for FBIOX is low at 0.83% and the ETF fees are not significant considering the net return.If we take into account that the FBIOX fund does not include the 2013 appreciation then the investment returns are about the same. Fidelity Investments has become a major player in biotech not just with FBIOX but they are adding life science  stocks to many of their other growth and technology funds.

Look at another “Five Star” rated life sciences mutual fund, T.Rowe Price Health Sciences (PRHSX $43.87). This fund is larger than those listed above with $5.02B in assets and more diversified with large cap companies. The returns are slightly less at 52% for five years and  26.3% for one year.

So without a detailed analysis of the holdings of each ETF or mutual fund we have come to the same conclusion as we did in 5/11:

1. During a bull market in biotechnology, mutual funds and ETFs can deliver good returns with less risk than individual stocks.
2. The portfolio should be balanced by picking one ETF and one fund e.g. IBB with FBIOX.
3. The XBI has been outperforming the IBB over the past month probably due to the addition of smaller cap companies that have greater volatility.
4. A smaller (asset value $240M) more volatile ETF the FBT ($49.50) is up 97% over 5 years, and 33.5% over one year.
5. No doubt a big factor in driving performance is that both hedge funds and larger cap mutual funds can significantly boost their stock selections due to a limited supply of quality companies. And if they discover a new Company they can create their own winners if volume is low and shares are thinly traded. Many of the funds own the same larger cap winners such as Alexion Pharmaceuticals (ALXN), Biogen Idec (BIIB), Celgene Corp.(CELG), Gilead Sciences (GILD) and Regeneron Pharmaceuticals, Inc. (REGN).

For a  more detailed review of individual stocks see the Rayno Life Science Portfolios for Biopharmaceuticals and Diagnostics/Tools.