Biotechnology stock pickers have to meticulously comb through a lot of startup businesses to finally land on a diamond in the rough. On the other hand, investors may also consider biotech exchange traded funds as a way to gain a diversified position for the overall sector.
According to Paragon Report, the recent FDA Amendment Act of 2007 has forced the biotech sector to accept more strict standards for approvals on new drugs, including mandatory risk evaluation and mitigation strategies. Consequently, pharmaceutical firms have shifted from primary care driven blockbuster drugs to specialized, niche products targeting oncology, immunology and inflammation, where the need is "so high that prices are more easily accepted by regulators," according to a IMAP Pharmaceuticals & Biotechnology report.
Kaul, the portfolio manager of Fidelity Advisor Biotechnology Fund, draws similarities between the biotech industry and Silicon Valley circa 1984 when startups began their 25 year boom. "My long-term view is that the next five, 10, 15, 20 years for the [biotech] industry will be one of the most promising places to be in the world," Kaul said in a Bank Investment Consultant article. "The quality of drugs in the pipeline should improve," which, he believes, would fuel future growth.
The biotech industry has "one of the best business models in the world," with high barriers for entry, high margins and long copyright protections. Kaul, though, cautions that investors have "to be conscious of minimizing the risk of blow-ups and disappointment in the labs," highlighting the difficulty in discovering a workable and potentially lucrative wonder drug.
Investors, though, may gain broad exposure to the overall sector and limit their risks to individual holdings through ETF products.
The iShares Nasdaq Biotechnology ETF (NASDAQ:IBB) is the largest biotech ETF, with $2.21 billion in assets and a 0.48% expense ratio. IBB is up 29.0% year-to-date. The SPDR Biotech ETF (NYSEARCA:XBI), with a 0.35% expense ratio, and First Trust Amex Biotechnology Index ETF (NYSEARCA:FBT), with a 0.60% expense ratio, follow an equal-weight methodology that emphasizes mid- and small-cap stocks. As smaller companies have the most to gain in discovering a new breakthrough drug, they will experience larger swings, which have also translated to larger gains in both these equal-weight funds. XBI has gained 35.4% year-to-date and FBT has increased 33.0% year-to-date.
SPDR S&P Biotech ETF
Max Chen contributed to this article.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.