Three Bogus Biotech ETFs… And One Great One

| December 29, 2009 | 0 Comments

There’s been a lot of buzz around the office lately.  One industry has us on high alert as we prepare to enter the second decade of the 2000’s. There’s a slew of favorable factors coming together that could propel the biotech industry to the stratosphere!

Now to be honest, the best way to maximize your profits investing in biotech stocks is having a seasoned analyst guide you.  And my fellow analyst and editor, Robert Morris, is one of the best in the business.

To reap maximum benefit from this coming boom, individual stocks are the way to go.  However, ETFs are my specialty.  And ETFs do provide an easy way to add a cross section of the biotech sector to your portfolio.

The bottom line is… having some exposure to this sector’s explosive potential is better than nothing at all.

But beware, all biotech ETFs aren’t created equal.  Selecting the right ETF in ’09 meant the difference between +45% returns and just breaking even!
Clearly we need to look under the hood of the six different biotech ETFs you can choose from.  Here they are–

  • Biotech HOLDRs (BBH)
  • PowerShares Dynamic Biotech & Genome Portfolio (PBE)
  • PowerShares Global Biotech Portfolio (PBTQ)
  • iShares Nasdaq Biotechnology Index Fund (IBB)
  • SPDR S&P Biotech ETF (XBI)
  • First Trust Amex Biotechnology Trust (FBT)

Right off the bat I’ll throw out BBH, PBE, and PBTQ.

The Biotech HOLDRs (BBH) is one of the most bogus ETFs I’ve seen.  It doesn’t track an index so it doesn’t rebalance its holdings.  Over time, the success of a few companies has skewed the holdings.  About 80% of the ETF is invested in three large cap companies.  It really isn’t constructed in a fashion that’s suitable to investing.

Number 2 and 3 on the bogus list are the PowerShares ETFs – PBE and PBTQ.  The guys over at PowerShares keep trying to come up with new and inventive indexes for their ETFs to track.  The problem is their new ‘intelidex’ ETFs consistently underperform other sector indices.  (Who wants to own the industry underperformers… I know I don’t!)

And here’s the icing on the cake.  PBTQ only trades a few thousand shares per day.  It’s not liquid enough to support buy and sell orders.  This results in a huge bid – ask spread quickly eating into your profits.

That leaves us with three possibilities – IBB, XBI, and FBT.

All three pass the basic ‘smell’ test.  They trade enough volume to buy and sell without worry.  The fee structures are manageable.  And, they aren’t too heavily invested in a limited number of stocks.

So it comes down to past performance and index construction to pick the best biotech ETF.

iShares Nasdaq Biotech Index Fund (IBB) holds 126 biotech stocks listed on the Nasdaq exchange.  This ETF holds a large cross section of small, medium, and large cap stocks.  And it’s quite possibly the best gauge of the biotech sector’s overall health.  So far the YTD return for IBB is just shy of 17%.

IBB is a market cap weighted index.  That means they invest a small amount of capital in small cap stocks.  The underweighting of the small cap stocks in the sector will keep IBB from fully capturing the explosive potential of biotech investing.

SPDR S&P Biotech ETF (XBI) and First Trust Amex Biotechnology Trust (FBT) both hold far fewer stocks than IBB.  And they have each outperformed and underperformed IBB over periods of time.

XBI holds only 28 stocks representing a cross section of small, medium, and large cap stocks.  XBI’s drastically underperformed in ‘09.  It’s only managed to eek out a meager 1% gain YTD.  XBI is a perfect example of a great idea underperforming because the index it’s built on isn’t up to par.

The best performing (and my favorite) biotech ETF of 2009 is the First Trust Amex Biotechnology Trust (FBT).

FBT’s posted gains in excess of 45% this year!  FBT’s secret is an equal dollar weighted index.  This weighting method gives small cap stocks a bigger influence than a market cap weighted index.

The secret is investing the same amount in the “Big Guys” as the small start-ups.  That way you get steady growth and explosive upside potential.

So remember, when it comes to investing in biotech, the really explosive gains come from small companies bringing new drugs and treatments to market.  This gives FBT an edge over other biotech ETFs year in and year out.

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Category: ETFs

About the Author ()

Corey Williams is the editor of Sector ETF Trader, an investment advisory service focused on profiting from ETFs and the economic cycle. Under Corey’s leadership, the Sector ETF Trader has become one of the most popular and successful ETF advisories around. In addition to his groundbreaking service, Corey is the lead contributor to ETF Trading Research, where he shares his insights about ETFs and financial markets on a daily basis. He’s also a regular contributor to the Dynamic Wealth Report and the editor of one the hottest option trading services around – Elite Option Trader.

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