ETF Folly: Biotech ETFs, Nothing but Confusion

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24/7 Wall St. has always wondered about the confusing universe of biotech exchange-traded funds (ETFs). Biotech stocks can rise or fall regardless of the market direction, and the sector performed very well in 2012 and is off to a good start in 2013. The problem is that the ETFs tracking biotech do not really grab the interest of investors as much as other sector ETFs. The beauty of these ETFs is that you are very unlikely to walk in and find your biotech shares down by 40% overnight in one of the key ETFs. The same cannot be said about investing in any of the individual biotech stock flavors of the day.

Perhaps one of the problems is that biotech stocks are not all created equal. It turns out that not all the biotech ETFs are created equal either. While they are all somewhat close in their fee structures, the four major biotech sector ETFs we follow are very different from each other. The biggest caveat for any investor is to understand exactly what you are investing in. We worry that investors either have no clue here in biotech or that they are just taking a shot in the dark.

Many of the holdings look and feel the same if you judge them on the surface. If you dig deeper, the holdings are much different in reality. The big concern for investors is that these biotech ETFs all march to a different drum beat, and the largest positions in each of these may greatly pump or hinder their performance.

iShares Nasdaq Biotechnology (NASDAQ: IBB) has a market cap of $2.17 billion with some 14.8 million shares outstanding. Its average daily volume is tiny at about 379,000 shares, compared to the largest and most active biotech stocks. Its expense ratio is fairly light at 0.48%. The iShares flavor of biotech ETF tracks the Nasdaq Biotechnology Index. What is interesting about this ETF on its weighting page is that Regeneron Pharmaceuticals Inc. (NASDAQ: REGN) is the single largest component, with a weighting of 8.37% of the fund, despite having a $16.3 billion market cap. That market cap is less than half of the next three ETF components shown here by weighting and by market cap: Gilead Sciences Inc. (NASDAQ: GILD) 8.23% weighting versus a $65.4 billion market cap; Amgen Inc. (NASDAQ: AMGN) has a 8.02% weighting yet it has a $70 billion market cap; and Celgene Corp. (NASDAQ: CELG) has a 6.81% weighting with a $43.6 billion market cap. Alexion Pharmaceuticals Inc. (NASDAQ: ALXN) has a 6.41% weighting of this ETF and a market cap of $16.9 billion, while Biogen Idec Inc. (NASDAQ: BIIB) has only a 5.53% weighting yet a market cap of $39.6 billion.