A More Viable Way To Tap Into Pharmaceutical and Biotech Investing

biotechJJ Feldman:  Tapping into the pharmaceuticals (pharma) and biotechnology sectors can be intimidating, and picking winners in this corner of the health care market is tough.

Failed trials, Food and Drug Administration (FDA) concerns and pricing issues have hit a number of companies in this sector lately, turning winners into losers overnight.

A recent example of how sensitive this sector can be comes from a short tweet from Democractic presidential front-runner Hillary Clinton about how she plans to curtail “price gouging” in the pharma and biotech sectors. This news sent both sectors into a nose dive.

A few days later, a Democratic congressman suggested that they are going to try and subpoena the CEO of Valeant Pharmaceuticals. Valeant is notorious for acquiring drugs and then raising the prices. They also spend far less on R&D than the typical company in the industry.

Many investors feel uncomfortable investing in the space without a medical degree because of the scientific and medical jargon in industry reports or on the companies’ website.

For those unfamiliar with the nuances of the pharma/biotech world, Exchange Traded Funds (ETFs) offer a potentially easier way to gain access to the space without all of the single security risk.

Ultimately, ETFs are an outstanding investment vehicle for those investors who are seeking specific sector exposure without having to conduct due diligence on each individual company.

The pharma/biotech group is the top-performing sector and has sustained the bull market since 2009. Industry trends have contributed significantly to this performance.

There is a great amount of innovation happening in both big and small pharma/biotech companies, including breakthrough new drug launches and scientific advances. Additionally, merger and acquisition (M&A) activity has been at a record high in this space.

Large companies such as Celgene are making licensing deals and partnerships with smaller companies, such as Juno Therapeutics and Bluebird Bio. At the same time, smaller companies, such as Pharmacyclics, are being acquired by bigger players, like AbbieVie.

There have even been rumors that Pfizer is interested in Allergan. Recently, Allergan sold its generics unit to Teva for $38 billion in cash.

This will leave Allergan with a pristine balance sheet and it will likely be on the hunt again once the deal with Teva closes. Clearly, consolidation in this industry will certainly continue to happen.

Two ETF’s to pay attention to are XBI and FBT. XBI is the SPDR S&P Biotech ETF that owns nearly 100 names both big and small with the largest position representing no more than 1.25% of the portfolio.

As of late July 2015, XBI was closing in on a 40% return for the year, but since then has had a massive pull back and is flat for the year (still outpacing the S&P 500 which is -6%) .

The market itself was experiencing significant volatility and is in the midst of a correction. Clinton’s tweet was like throwing gasoline on a fire for the pharma/biotech sectors.

FBT is the First Trust NYSE Arca Biotechnology ETF. This holds 30 names and equally weights them.

FBT’s portfolio is less diversified than XBI in terms of holdings however the median market cap skews much higher than XBI.

This means that FBT is likely to be slightly less volatile than XBI since FBT tends to hold bigger sized companies. Both ETFs have performed exceptionally well over the respective 1-, 3-, and 5-year periods, trouncing the S&P.

Pharma/Biotech is a great sector to invest in, however it is prone to significant corrections and does have significant volatility both on the upside and downside.

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