Biotech Investment Ideas

Biotechnology was the best performing sub-industry, up 288.5% from 2011-2014, ahead of the S&P Health Care Sector and the broader S&P 1500 indices gains of 118% and 64%, respectively. Year to date through June 6, the 9% gain for broader market's 2.0% return. According to Jeffrey Loo, S&P Capital IQ's head of health care equity research, there are a number of catalysts. He highlighted that in 2014 several high profile blockbuster drugs were approved by the Federal Drug Administration (FDA) and sales for the seven biotech companies in the S&P 500 index rose 41.5% in 2014, while net income rose 85%. Looking forward, these companies have robust pipelines, with expectations that 10-12 compounds could be approved by the FDA in 2015 and are capable of achieving blockbuster sales in five years.

While the biotechnology industry has strong growth prospects, Loo points out that Amgen (AMGN) and Gilead Sciences (GILD) also pay dividends comparable to other more mature health care companies.

Despite the strong gains for the industry the last few years, biotech is far from expensive in our opinion. Indeed, the S&P 1500 Biotechnology industry trades at forward P/Es of 18.2X (2015) and 15.2X (2016), below that of the health care sector's 19.3X and 16.5X and the broader S&P 1500 index's 18.4X and 15.9X, respectively.

In the first five months of 2015, investors focused most of their equity ETF assets toward international products tied to the MSCI EAFE index and others. However, among U.S. sector ETFs, diversified health care and biotechnology specific products were highly popular.

iShares NASDAQ Biotechnology (IBB) is the largest biotechnology focused ETF with $8.8 billion in assets. It has climbed 21% for the year to date through June 6 and 45% on an annualized basis over the past three years. IBB is among the more concentrated of the sector/industry ETFs, with recent top-10 holdings representing 57% of assets. However, all of these stocks are ranked by S&P Capital IQ as Buys or Strong Buys, including AMGN and GILD. The ETF has a 0.48% net expense ratio.

IBB had approximately $450 million of inflows during the first five months of 2015.

Meanwhile, SPDR S&P Biotechnology (XBI) has $2.4 billion in assets and has risen 31% thus far in 2015. Despite this stronger performance, the three-year return of 46% is just slightly higher than IBB. Looking at past performance alone, there might not be obvious differences between the two ETFs. However, as an equally weighted ETF, XBI has just 12% of its assets in its top-10 holdings. XBI has much more exposure to small- and mid-cap companies than IBB; XBI's weighted average market capitalization is $8.6 billion, far below IBB's $48 billion. Top-10 holdings include lesser known, but strong performing companies such as Prothena Corporation (PRTA) and Esperion Therapeutics (ESPR).

XBI, which gathered approximately $485 million in assets in 2015, has a net expense ratio of 0.35%.

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