In these volatile times, everyone is looking for ways to hide from market turmoil. For many investors, that means increasing allocations to gold, bonds, or dividend paying stocks. But we feel that there is another sector that can provide investors with a way to hid from market turmoil: biotechnology.
Why Biotechnology? The Answer is All About Fundamentals
For many investors, one of the most frustrating aspects of today's markets is the fact that for many public companies, fundamentals have begun to matter less and less. The market's obsession with macroeconomic headlines, and the volatile reactions to them have led to many companies rallying and falling based on no news at all. Companies such as Apple (NASDAQ:AAPL), Intuit (NASDAQ:INTU), or Costco (NASDAQ:COST) all rise and fall based on macroeconomic sentiments, even when they are not really affected by what happens in the broader global economy. One sector, however, has managed to retain the ability to trade on actual fundamentals, and that sector is biotechnology.
Current industry trends provide a good deal of support for the biotechnology sector. It is much more insulated from regulatory headline risk than the broader healthcare sector, and the need for large pharmaceutical companies to fill their pipelines and mitigate the effects of patent expirations, have led to a boom in mergers and acquisitions in the space. Many companies have been bought in the past year or so, such as Inhibitex and Ardea BioSciences. Others are targets, such as Human Genome Sciences (HGSI), while others are constantly the subject of rumors and speculations, such as Achillion (NASDAQ:ACHN) and Idenix Pharmaceuticals (NASDAQ:IDIX).
We invest in biotechnology in a way that may be different than that of most investors. For us, holding specific biotechnology companies outright is often too risky, and we tend to only hold individual names in the space while employing options strategies to minimize risk. If we do not see a compelling company to own, AND a good way to mitigate clinical trial/FDA approval risk, we do not buy that company. We do, however, hold 3 biotechnology ETFs, and it is those 3 that we would like to highlight as a way to hide from market turmoil.
A Trio of ETFs That Consistently Beat the Market
The three ETFs we would like to present are the SPDR S&P Biotech ETF (NYSEARCA:XBI), the iShares NASDAQ Biotechnology Index Fund (NASDAQ:IBB), and the First Trust NYSE Arca Biotechnology Index Fund (NYSEARCA:FBT) (from here, we will refer to them as the S&P, iShares, or First Trust ETFs, for the sake of brevity). We provide a quick overview of these ETFs below.
|# of Holdings||51||120||20|
|Beta (per Google Finance)*||0.8||0.74||0.95|
*Beta is calculated differently at various financial sources, and therefore may differ depending on each reader's preferred source of security information.
All 3 ETFs have lower beta's than that of the S&P 500 (NYSEARCA:SPY), and all have good expense ratios. Since the inception of the FIrst Trust ETF, which is the youngest one, in 2006, all 3 have dramatically outperformed that markets.
In addition, since the market reached its post-crisis high, all 3 funds have outperformed, both an a relative and absolute basis.
We believe that investors should diversify their haven assets to include these biotechnology funds, for they offer investors exposure to companies that are truly insulated form global economic pressure, as their performance is driven entirely by what occurs at a company-specific level. We own all three funds, and believe that is the best way to own them. But why own all three, and not just one.
When Three is Better Than One: A Look Under the Hood
In most cases, sector ETFs from differing providers have a good deal of overlap, the only real differences being in size, liquidity, price, and other quantitative factors. A good example is the SPDR Gold Trust ETF (NYSEARCA:GLD) and the iShares Gold Trust (NYSEARCA:IAU). The GLD is larger, and has much more daily volume, but the IAU has a lower expense ratio.
These three ETFs however, all hold different companies, as they track wholly different indices. The S&P fund tracks the S&P Biotechnology Select Industry Index. The iShares fund tracks the NASDAQ Biotechnology Index. And the First Trust fund tracks the NYSE Arca Biotechnology Index.
A biotechnology company held by one of these funds may not appear in the other two at all, or what may be a minor holding for one fund is the largest of another. And the differing number of holdings in each fund cal alter their performance. The First Trust fund, for example, has just 20 holdings, with their weights ranging between almost 8% down to 3.5%. Therefore, each individual company has a greater impact on performance. The iShares fund, on the other hand, has 120 holdings, with weights ranging from anywhere between 8% and almost 0%. The S&P fund has 51 holdings, and no single stock is more than 3.5% of the fund.
We own all three ETFs because on their own, none of them are able to provide exposure to the complete biotechnology sector. For example, Arena Pharmaceuticals (NASDAQ:ARNA) makes up just 0.64% of the iShares fund as of this writing. But it is the largest holding at the S&P fund, with a weighting of 3.43%. When combined, these 3 funds offer investors a diverse way to gain exposure to the biotechnology sector without having to be exposed to company specific risk.
Conclusions & A Note of Caution
In our opinion, the biotechnology sector offers investors another way to hide from the market's gyrations. This sector is well-insulated from macroeconomic pressure, and is driven by fundamental, company-specific news, something that has become increasingly rare in a market that is controlled by headlines and sentiment. We believe that owning these 3 ETFs is a good way to gain broad exposure to this sector.
However, we remind investors that the biotechnology sector should not be seen as a replacement for more traditional safe havens, and we do not recommend that investors sell off other safe-haven assets to invest in these funds. We own them alongside traditional hedges against market volatility and crisis, including gold and a short ETF (NYSEARCA:HDGE). That being said, we think that biotechnology stocks have a place in a solid, well rounded portfolio, and that when invested in properly, this sector can provide investors with another way to help shield their portfolios from market turmoil.