Both the iShares Nasdaq Biotechnology ETF (NASDAQ:IBB) and the SPDR S&P Biotechnology ETF (NYSEARCA:XBI) are popular vehicles to play the biotechnology sector as both provide investors the required diversification in order protect against large price swings in individual biotech stocks. Over the last several years, both these ETFs have delivered incredible returns. We will examine and compare these two ETFs to see which is better for long term investors.
IBB and XBI are both passive ETFs and have outperformed not only the broader market since 2010, but they have both trounced the returns of actively-managed biotechnology/life science mutual funds. As you can see, the Fidelity Select Biotechnology Portfolio (MUTF:FBIOX) and the Franklin Biotechnology Discovery Fund (MUTF:FBDIX) lagged the performance of IBB and XBI. For benchmarks, IBB is designed to track the performance of the Nasdaq Biotechnology Index, while XBI's benchmark is the S&P Select Biotech Industry Index.
As I mentioned previously, IBB is market cap-weighted. This means that IBB is mainly comprised of larger biotech firms with multiple products on the market. This weighting means the ETF will be less affected by binary results from small cap biotech stocks. Top holdings include stalwarts like Amgen (NASDAQ:AMGN), Gilead (NASDAQ:GILD), Celgene (NASDAQ:CELG), and Biogen (NASDAQ:BIIB). IBB has a total of 187 holdings, with the top 10 holdings comprising of 58% of total assets.
|Top 10 Holdings (58.07% of Total Assets)|
Source: Yahoo Finance
XBI, on the other hand, is equally weighted. As you can see, the top 10 holdings include Ionis Pharmaceuticals (NASDAQ:IONS) and Intrexon (NYSE:XON), two companies not normally equated with blue chip biotechnology firms. Given the even weighting of the ETF, XBI is more sensitive to the volatility of small biotech stocks. In total, XBI has 88 holdings, and the top 10 only comprise 25% of total assets.
|Top 10 Holdings (25.43% of Total Assets)|
Source: Yahoo Finance
It would not be prudent to ignore fees when choosing ETFs or mutual funds for investing. To put this in perspective, let's compare investing in IBB versus the Franklin Biotechnology Discovery Fund. IBB has a net expense ratio of .48% and FBDIX has a net expense ratio of 1%. If investor A purchased $10,000 of IBB and investor B bought $10,000 of FBDIX and both funds averaged returns of 10% of 20 years, investor A would have $61,102.79 and investor B would only have $55,024.69 As you can see, fees can be very costly and the results are magnified even further over time. These calculation excluded the maximum sales charge of 5.75% that investors would have to pay when initially investing in FBDIX. I compared expense ratios for IBB and FBDIX as the difference between IBB's and XBI's fees is almost negligible. XBI has a slightly lower expense ration of .35%.
With regard to tax implication, investors want to buy an investment product with a relatively low turnover. Passive ETFs are more efficient than mutual funds as the ETF's managers only have to buy and sell securities to match the composition of the underlying index. Conversely, a mutual fund manager is going to attempt to generate alpha for investors and outperform his benchmark by buying and selling individual securities. However, each transaction incurs taxable events. At the end of the calendar year, most mutual funds pass on the tax consequences to investors in form of a distribution. The drawbacks of actively-managed mutual funds is still present in tax-deferred accounts as a high turnover drags down returns. Much like traditional mutual funds, XBI has a high turnover as the fund managers have to constantly buy and sell securities in order to keep an even weighting for the ETF's holding. As a result, IBB is much more tax efficient. IBB has a turnover of 24% and XBI has a turnover of 78%.
In conclusion, IBB is an overall better investment than XBI (even considering IBB's higher expense ratio) when considering diversification, historical returns, and tax efficiency. IBB top 10 holding comprise of over 50% of the ETF's weighting as its returns are largely driven by large, profitable biotechnology company with multiple products available.
|5 Year Historical Returns||19.48%||17.92|
|Net Expense Ratio||.48%||.35%|
|Number of Holdings||187||88|
Disclosure: I am/we are long IBB, GILD, XON.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.