Daily ETF Folly: Why There Is No True Biotech Representation in ETFs
24/7 Wall St. is taking a daily aim at the world exchange-traded funds (ETFs). Many are great, and many are actively traded and truly represent what investors are trying to get exposure to. Other ETFs either have tracking issues or are not as representative as their names might indicate. Some ETFs simply have rather strange components and methodologies that investors do not easily grasp. Our aim is not to say that each ETF is bad, but we have one maxim when it comes to your personal finances: You must fully understand what you are investing in!
The biotech sector again leads our Daily ETF Folly.
Before we get into the biotech ETFs, we want to highlight two key issues. First is that biotech ETFs generally are not quite what an investor might think by the holdings and weightings. Second is that as a result of this sector’s ETF tracking, biotech stocks are by and large not dominated by the daily inflows and outflows of investors and traders speculating on the sector as a whole.
Don’t get us wrong. Speculators are involved in almost every single pre-FDA panel vote and ahead of just about every FDA formal approval announcement. The ETFs of the sector just do not swing the actual stocks in this sector one bit.
If you add up the four major ETFs for biotech, the total market value is small, as you will see in the tables below. This accounts for the largest in the sector as the iShares Nasdaq Biotechnology (NASDAQ: IBB) at $2.17 billion in assets, followed by the SPDR S&P Biotech (NYSEMKT: XBI) at $661 million, then the First Trust NYSE Arca Biotech Index (NYSEMKT: FBT) at $261.3 million and lastly by the Market Vectors Biotech ETF (NYSEMKT: BBH) at only $185 million. The final tally for these four top biotech ETFs is a total of $3.28 billion.
If you tally up the dollars traded each day in Amgen Inc. (NASDAQ: AMGN) of about $500 million, that stock alone trades much more in dollars traded each day than you see in all of these ETFs combined. The good news is that the biotech sector is not jacked around or held hostage each trading day by ETFs. The bad news is that this is simply because the four major biotech ETFs generally are not representative of the sector.
24/7 Wall St. added up the market capitalization rates from the Yahoo! Finance sector screens with a market cap of more than $5 billion for the companies that appear in one of the four major biotech ETFs. That came to $287.3 billion in combined market capitalization rates in only the 12 companies with $5 billion values and higher. That does not include all the dozens and dozens of other companies worth less than that.
We have show how each of these miss the mark for investors wanting biotech exposure. The one that does actually track like a normal ETF is also heavily dominated by the largest four companies, and it is actually the lowest in total assets under management and is deemed too low in average daily volume to be considered active and liquid for many investors.
The only true market cap-weighted ETF by Van Eck is called the Market Vectors Biotech ETF (NYSEMKT: BBH), as it tracks the 25 largest biotechs by market cap. Unfortunately, this ETF is also still living in the shadows of being a HOLDRS ETF, which had a very poor mix due to the way that old family of ETFs was constructed before Van Eck took it over. That is the most fair of the four major biotech ETFs. Unfortunately, the bottom five of the 25 components only have a combined weighting of about 5.3%, versus a combined weighting of about 46% for the top five components.
The First Trust NYSE Arca Biotech Index (NYSEMKT: FBT) is another biotech ETF flavor that is unique because it has 20 components and it resets each quarter with a 5.0% equal weighting for each component. This keeps the $67.7 billion Amgen Inc. (NASDAQ: AMGN) and the $63.9 billion Gilead Sciences Inc. (NASDAQ: GILD) from overly dominating the ETF. Unfortunately that allows a player like Sequenom Inc. (NASDAQ: SQNM) and its myriad of problems from the past to have the same weighting at the start of each quarter in the ETF.
So, we have complained over and over about the sector of biotech ETFs. There has to be a solution of some sort. Due to the market capitalization gaps being so large between the huge companies and the rest, there is no easy solution. This still does leave room for a more actively managed ETF in the biotech space, or perhaps an ETF could be created based solely on pipeline biotechs in various stages of development, but without drugs on the market. Maybe a large-cap ETF would come in and take the top 15 by market cap and not allow any member to have more than a 10% weighting.
You probably get the point here. The biotech sector ETFs by and large fail to make the grade for what would be active and large ETFs that truly track their intended sectors, even if they do track an index or a derivation of that index. This leaves room for more entrants that want to launch biotech ETFs.
Below is our table of the major biotechs by market cap, and here is a much more detailed piece on why each of the four major biotech ETFs miss the mark for investors seeking biotech diversity.