Biotech ETFs: Can You Handle 209% Volatility?

Years ago, I thought that I could divine the future of the biotech companies. Account damaging stock gaps from failed “sure thing” phase–three studies and unexpected drug side-effects required a reassessment of how to successfully invest in the sector. Fortunately, before long I realized that foretelling a novel compound’s efficacy and long term safety was beyond my prophetic ability.

Most industry group sub-sectors have a high price change correlation among component companies; however this is not the case with biotechnology. This characteristic suggests that a shotgun approach will be a logical path to success.

The biotech industry in aggregate creates many successful marketable compounds, with ensuing product profits much greater than the sum of cash burn, and long safety issues with resultant litigation expenses, etc. Thus, a more effective way to gain exposure is by using an ETF; select carefully though, as company weighting methodologies can vary greatly among ETF managers.

For example, currently the Biotech HOLDRs ETF (BBH) has a huge 39.5% allocation to Genentech (DNA), whereas the SPDR S&P Biotech ETF (XBI) has a maximum of 6.1% in any one company. Also, as you would expect, with diversification we can expect a less-wild ride; using daily closing price, the sixty-day standard deviation of XBI is 25.7%, whereas the same for BIIB is 83%, and for Elan (ELN) a gut-wrenching 209.2%.

Disclosure: Author holds a long position in XBI

Comments

[Kayboe:]

I too am long XBI because I believe the only way to invest in biotech is with an ETF or standard mutual fund. I have a fairly tight stop on this one and it makes up only a small percent of my total portfolio.

2008 Aug 25 11:56 AM