Life Science ETF’s: Strategy and Composition

There are several ETF’s with biotech and drug positions but the three that are large, liquid and better known with asset values are : First Trust Amex Arca Biotech Index (FBT,$166M) , iShares Nasdaq Biotechnology (IBB, $1.38B) and SPDR S&P Biotech (XBI, $487M). All of these ETF’s have significant positions in the largest, most liquid and most profitable biotechs (anchors) but the composition of each can be quite different among the more speculative companies. Investors should balance out their life science portfolio with one or two of these ETF’s to reduce volatility due to clinical developments or earnings shortfalls. For example all of these ETF’s have up to 20% allocation to the following 4-5  larger cap biotechs: Amgen (AMGN), Biogen (BGEN), Celgene (CELG), Cephalon(CEPH) and Gilead (GILD). Positions in the second tier or Mid-Cap, more volatile biotech stocks can vary significantly and this is the performance differentiator when breakthrough clinical news or M&A activity is announced. Many hedge funds use the ETF’s as a hedge or to overweight when the sector is hot. All the ETF’s will tend to move in lock step with unusual sector strength or weakness. Today Celgene (CELG) a large cap biotech was down 8% due to a risk of cancer with one of their drugs. Here is how the XTF’s fared today : FBT $35.16 down 0.68%, IBB $88.94 down 0.49%, XBI $60.93 down 0.25%.

Here is a brief overview of each ETF with performance YTD. Biotech stocks overall have been relatively quiet in 2010 but market performance tracks the NASDAQ and by some metrics outperform other healthcare indices. Seasonality is usually good from Nov.-  to mid January.

First Trust Arca Biotech(FBT)       The Recent Outperformer

This is a relatively new, smaller ETF that went public in 2006  at about 20 and is currently trading at 35 giving it a 3 Year annualized return at about 11% despite the downdraft in late 2008. Performance YTD on NAV is 23%. FBT differs from other ETF’s on composition and number of positions. For example among the Top Ten positions are four  life science tools and diagnostic companies Celera (CRA), Illumina(ILMN), Lifetech(LIFE) and Qiagen (QGEN) constituting over 20% of the portfolio. The Top Ten positions are over 50% of the total. With respect to style, FBT has positions in companies that are earlier stage, more volatile but have a lot of upside potential with M&A or positive clinical data: Affymax(AFFX),Dendreon(DNDN),Sequenom (SQNM), Nektar (NKTR) and Vertex (VRTX). Stock picking has been  important in FBT for example  with recent hits in Human Genome and Dendreon over the past 18 mos.

iShares Nasdaq Biotechnology Fund(IBB)        The Largest and Most Diverse

IBB is one of the oldest (inception 2/05/01)and largest biotech ETF’s with many of the familiar names but with many positions in smaller companies as well as pure play drug companies. Among the Top Ten positions are two generic drug companies Mylan (MYLN) and Teva (TEVA) as well as tools leader Illumina(ILMN). Since fund inception the IBB is down a cumulative 9.6% but up an ave. annual 2.3% over 3 years as of 9/30/10. The ETF is up  7% YTD and has over 100 stocks in the portfolio. Because the fund is large with over $1.3B in assets it is highly diversified even with $1M+ positions in many small caps such as Albany Molecular (AMRI $5.20), Arqule (ARQL $5.60), Maxygen (MAXY $6.75 ), StemCells (STEM $1.15 ) and  Supergen (SUPG $2.78). Virtually every life science stock that is in a fund or on any radar screen is in IBB-tools, drug delivery,tools- so the performance depends on the weighting, re-balancing and stock picking. While this strategy curbs volatility it also limits big upside moves. IBB managers need to be adept at overall knowledge of biotech because of the number of positions.

XBI SPDR S&P Biotech(XBI)-State Street Global Advisors      Pure Play in Emerging Biotech Drugs

The XBI  is a mid-sized ETF with 31 holdings that was created on 1/31/06 .Cumulative return for that period is 4.26% as of 10/31/10. YTD returns are 7.3%. The Top Ten Holdings have none of the the usual large cap suspects instead focusing on a number of higher beta mid-caps such as Alexion(ALXN), Biomarin (BMRN),Regeneron (REGN), Seattle Genetics(SGEN), Theravance (THRX),United Therapeutics (UTHR) that have later stage clinical products or have M&A potential. One small cap,high growth diagnostic Company Cepheid (CPHD) is 3.93% of the portfolio and up 75% YTD. The Top Ten positions comprise about 40% of the portfolio. Large caps are still a big 20%of the portfolio with Amgen (AMGN),Biogen (BGEN),Celgene (CELG),Cephalon (CEPH),Gilead (GILD)and Genzyme (GENZ). A few other smaller biotech companies supplement these core positions. XBI is the most “pure-play” biotech Company with few positions in smaller caps or tools and diagnostics.

Chart forSPDR S&P Biotech (XBI)

Tom Lydon wrote an article on EFT Trends on October 21 that discussed 5 Things That Drive Biotech ETF’s one of which could be affected by politics and government funding as the Republicans come into power. Key drivers are government funding from NIH,patent regulations and VC financing.

5 Things That Drive Biotech ETFs | ETF Trends

Money for Science May Be Scarce With New Congress –

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