Biotechnology is a notoriously volatile industry. Shares of individual firms often skyrocket or plummet based on clinical test results. Because biotechs tend to march to the beat of their own drum--share prices are much more sensitive to clinical trial results and merger activity within the sector than they are to the economic backdrop—they can be an interesting small addition to a satellite portfolio.
We think investing in the industry via an ETF makes a ton of sense. With a single transaction, investors can achieve instant diversification and mitigate the risk of being too exposed to any one firm. PowerShares Dynamic Biotech & Genome (PBE) might fit the bill for investors seeking to easily add some biotechnology exposure to their portfolios.
This exchange-traded fund tracks a dynamic index consisting of 30 biotech stocks. The index is governed by a quantitative model that aims to surpass the returns of traditional indexes by investing in stocks that display favorable fundamental growth, attractive valuation, and momentum traits. Investors should note that the weighting methodology applied here translates into higher exposure to firms with small market capitalizations. In fact, large-, mid-, and small-cap stocks make up roughly 13%, 43%, and 44% of total assets, respectively. Still, this ETF provides exposure to firms ranging all across the product-development spectrum, from those that boast blockbuster drugs--like Amgen (AMGN) and Genzyme (GENZ) --to others that lack a single approved drug--such as Immunogen (IMGN).
The chances of a biotech getting a blockbuster drug through clinical trials and onto the market have been likened to those of going to Hollywood and becoming a star. Industry experts estimate that one in five therapies, at most, will survive the 10- to 15-year development and clinical gauntlet required to get regulatory approval. With the process costing $1 billion, on average, many biotechs surrender their drugs' marketing rights to big drug firms in exchange for cash upon reaching various development milestones. Thus, biotech firms lacking an approved drug have highly irregular cash flows.
Of course, with that risk and volatility comes great opportunity. Firms that develop innovative therapies and successfully get their products to market stand to reap bountiful rewards. Merger activity has also heated up in the industry, providing another potential catalyst. The headliner of the bunch, of course, was Roche's (RHHBY) acquisition of Genentech.
