Review of Life Science Funds and ETF’s up 15% YTD

Edited Version Published in Investor Uprising June 2011 :Updated here JY 16, 2011

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follow link Biotechnology Has Outperformed the S&P Over Five Years

Medical science has always been an important area for investors and recent breakthroughs with new drugs and devices have eclipsed many of the concerns of Health Care Reform. Health and life sciences are one of the best performing market sectors in 2011. Many investors have shied away from the biotechnology sector due to lack of reliable earnings or the seemingly endless need for cash to fund R&D. Small and mid cap life science stocks cannot be analyzed solely with a fundamental perspective as there are many other drivers such as intellectual property and  the food chain effect of M&A.

For the individual investor stock-picking in biotech can be time consuming. Is your knowledge of molecular biology up to date? Are you familiar with targeted therapies utilizing humanized monoclonal antibodies? What is autologous therapy? What does RNAi do? Are therapeutic stem cells commercialized? What is personalized medicine?

Are you willing to spend the time following medical news and understand the scientific basis for novel therapies in biotechnology, especially analysis of clinical data and the FDA regulatory implications? If the answer is yes then you may be ready to become a biotech trader especially if you can read a chart pattern. If not, mutual funds and ETF’s are the investment vehicles of choice for life science investors. source url The key point of biotech investing is a portfolio approach with at least ten positions including ETF’s. And unlike arcane ETF’s in commodities, real estate and other sectors, your positions will be easier to understand and will track indices.

The 2 Year Bull Market for Biotechnology Stocks

Health Science Mutual Funds

Recent mutual fund data shows investments in health and life sciences are up 13% through April and here are updated returns as of July 16,2011. Some of the leading funds in the sector : T.Rowe Price Health Sciences Fund (PRHSX) up 18.43 %, Fidelity Select Biotechnology (FBIOX) up 18.49%, BlackRock Health Sciences Ops Inv A (SHSAX) up 13.9% and the Vanguard Healthcare ETF (VHT) up 14.04%. In 2011 even the laggard drug stocks have rallied for example the Fidelity Select Pharmaceuticals Fund (FPHAX) with a four star Morningstar rating is up 14.54% YTD. Large cap drug stocks have participated in the life science rally because they are sought out by dividend investors, tend to be value plays with strong underlying financials and have the core technology for creating product pipeline. The overall life science and healthcare sector is very strong so major ETF’s have tracked performance of the mutual funds up about 15% YTD. ETF’s and funds that are over weighted in larger cap, blue chip drug companies such as XLV and VHT may offer more defensive positions in a down market due to quality of earnings but over the past five years this has not been the case.

Comparing mutual funds to ETF’s can be more difficult due to loads, fees and taxable distributions. Healthcare funds weighted toward large cap stocks and lower risk may not be positioned in emerging biotechnologies and mid to small cap growth stocks.

Comparison of health science funds:

Symbol            Price    Asset Value $B        1 Yr.    5 Yr. (%Returns)

PRHSX           35.60   2.8                               37.72   40.6     10.4% annualized 5 years

FBIOX            84.58   1.23                             29.75   35.75   6%

SHSAX           31.95   1.43                               17        29.8     9.56

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Underlying trends in biotechnology

Recently we published a review of underlying trends in the biotechnology market. Some of these trends could account for the out-performance of the life science sector especially when compared to large cap drugs:

  • M&A: many mid and small cap biotechnology, tools and diagnostic companies are being merged or acquired providing big stock boosts.
  • Paradigm shifts in medicine: new technologies have been developed by smaller companies that transform drug development e.g. genomics, biomarkers and sequencing
  • New therapeutic approaches: most of the Top Ten selling biological drugs are monoclonal antibody therapies that have been developed by biotechnology companies in partnership with major drug companies.
  • New markets and technology convergence: orphan drugs, connectivity of patient to physician, and emerging markets for a new source of  revenue growth.

Major ETF’s in the Life Science Sector

Here are three of the most liquid biotech ETF’s compared to the QQQ Nasdaq-100 ETF.(The SPY -S&P return was 6.61%):

5/6/11 Price Net Assets $B Trading Range-52 Wk    1 yr.    5 yr. (% Return) ETF Rating* Price July 16 Five Year Return%

FBT 44.26               0.218      29.40-45.50                           39.5     122                              5.1 43.1   107.3

IBB 106.49             1.63         74.50-109.61                          28.9     36.5                            7.1 107.3  56.2

XBI 72.29               0.471      47-75.17                                   35        51                                 6.4 74.2   71.4

QQQ 58.47           49.1          41.77-59.34                             28.75   38.7                            8.6 57.8   53.5

* The ETF rating is provided by xtf.com

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First Trust Amex Biotechnology Index Fund (FBT) Inception 6/19/06

This ETF closely tracks the NYSE Arca Biotechnology Index, an equal dollar weighted index that measures the performance of a cross section of companies. The NYSE Arca Biotechnology Index has outperformed the S&P 500 over 5 years by about 117% and over one year by 13 percentage points. It is rebalanced quarterly on the third Friday of the month. About 20 stocks are included in the fund with a ~5% weighting of ten mid-larger cap ($5-50B) stocks such as Biogen Idec Inc. (BIIB), Celgene Corp. (CELG), Life Technologies Corp. (LIFE), Regeneron Pharmaceuticals, Inc. (REGN) and Vertex Pharmaceuticals Inc. (VRTX). The beta for the fund is 0.89 slightly more volatile than the S&P 1500 healthcare index of 0.69. The fund is relatively small with concentrated positions in the leading companies with few small cap speculative positions. Use of options and short selling is permitted. Expense ratio is 0.66%.

Nasdaq Biotechnology Index Fund (IBB) Inception 2/5/01

The iShares Nasdaq Biotechnology Index Fund, managed by Blackrock Institutional Trust Co, N.A., seeks investment results that correspond generally to the price and yield performance of companies engaged in the biotechnology index as represented by the NASDAQ Biotechnology Index. The IBB has outperformed the S&P 500 by about 34% since mid 2008 and over a one year the performance by 4 percentage points. The sector breakdown is 66.74% biotechnology and 33.50% pharmaceuticals with large cap biotech stocks among the top 7 holdings totaling 33.7% with the major players: Amgen, Celgene, Gilead, Teva (now acquiring Cephalon (CEPH), Vertex etc.The top 20 positions are about 67% of the portfolio. The IBB is different from other ETF’s in that it has many mid and smaller cap companies beyond its top twenty positions making it highly diversified yet still concentrated in the well capitalized names with growth in revenue and earnings. As an example the Fund may have at any given time as many as 125 stocks in total but 100 may have less than a 1% holding. Some of this diversification includes small cap companies that are:

  • Discovery or clinical development stage or in biomedical research hence more speculative.
  • Focused in tools and diagnostics including mid and small cap growth.
  • Innovative technology platforms that have valuable intellectual property with multiple product applications.

Depending upon the analytics used and the frequency of rebalancing the IBB may be able to spot big winners on their radar screen and weight appropriately. In the current life science bull market this can provide an advantage as speculative stocks with good clinical news or involving major deals can appreciate quickly. As a case in point Human Genome Sciences, Inc. (HGSI) has soared from $2.50 to $27.75 over 24 mos. and Exelixis, Inc. (EXEL) up 300% to $11 over one year. The beta is the same as the S&P 500 Index and hedging with options and futures can be used. The turnover rate for the portfolio is 11%. The expense ratio is 0.48%.

The SPDR S&P Biotech ETF (XBI) Inception 1/31/2006

The S&P Biotechnology Select Industry Index represents the biotechnology sub-industry portion of the S&P Total Markets Index. It tracks all the U.S. common stocks in all exchanges on an equal weighted market cap basis. The XBI has outperformed the S&P 500 Index since May 2006 by about 49% and over a 1year period by 6 percentage points. The five year performance at the end of the last quarter is 6.19%. The fund has a low turnover of 74 days with about 48 holdings concentrated in the large cap names with an average market cap of $6.4B.The Top Ten holdings comprise about 29% of the portfolio with the usual well known companies: Amgen, Biogen, Celgene, Gilead and Vertex. Two of the top ten names include stocks have made big moves and are at an earlier stage of development. The expense ratio is 0.35%.

There are other ETF’s in the biotechnology sector but the three above including Vanguard’s VHT for large cap healthcare offer sufficient diversity for most portfolios. As another example BBH has a very high rating of 7.7 from etf.com but the fund is highly concentrated with 85% in three large cap biotechs but the portfolio is not managed and does not track a specific index. Expense fees are very low for that reason. BBH has underperformed other ETFs although it did have  a big winner when Genzyme was acquired by Sanofi- Aventis.

NYSE Biotechnology Index compared to Nasdaq-100 and S&P 500 index ETF’s over two years:

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Conclusions and Recommendations

1.)   Biotechnology or Life Science ETF’s track the sector well and are good investment vehicles to allocate stocks in a healthcare investment portfolio.

2.)   The Life Science sector has outperformed the S&P 500 over the past five years despite weakness in healthcare and large cap drug sectors.

3.)   Investors in biotechnology need a diversified portfolio to buffer the volatility of individual stocks. ETF’s can be added to portfolios for diversification and comparison.

4.)   Life science ETF’s track the NASDAQ PowerShares QQQ Trust Series 1 and complement the volatility of the tech sector. The QQQ holds all of the securities of the NASDAQ-100 Index. Over 5 years the QQQ’s returned 38% whereas the IBB returned 35%. In contrast the S&P was up only 1% due to the recession and financial crisis of 2008. The NASDAQ-100 has a very significant weighting of large cap biotech stocks.

5.)   Over five years the relative performance of the three most traded ETF’s were FBT>XBI>IBB. This may be due to better stock picking, more concentrated positions and better software technology. The IBB has a larger asset value and more small cap speculative stocks. However on a shorter term basis the relative performance may change.

Note: Some hedge fund managers have begun to reduce weighting and/or short the healthcare sector due to relative outperformance and anticipated budget cuts.

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