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With the economy poised to jump over the fiscal cliff in just a few days, investors are becoming all the more cautious as the risks are high for the U.S. economy to slip into another recession and the U.S. GDP to turn negative. This means the market would again be in a critical situation, and with little movement on the political front, many investors are on edge heading into 2013.
In such a situation, investors generally opt for sectors that are impervious to the economic cycle. In this context, we would like to highlight the Biotech sector ETFs which have a low correlation with the market (Biotech ETFs: A Fiscal Cliff Safe Haven?).
Beyond having a low correlation and demand levels that are relatively immune to the business cycle, another factor which makes it favorable for investment is that biotechnology companies do not offer high yields. If we get over the fiscal cliff, tax on dividends would be charged close to 45% which is much higher than the current 15% level.
So investors who invest in this sector do not have to worry about the high taxes on yield. Apart from this, the sector is also expected to post solid earnings going forward while many firms could be M&A targets as well.
This has been evident so far in 2012 as the space has been a solid performer this year. Still, even though a major point of uncertainty – the Affordable Care Act – appears to finally be going through, the space has its share of headwinds. Competition is broadly increasing in the sector thanks to generics in the pharma space (Forget Big Pharma, It Is Time for A Biotech ETF).
However, with the fiscal cliff looming large on the U.S. economy, investors looking for a defensive play among biotechnology companies have many options in the ETF space. In this article we would highlight what we think is one of the top picks in the space utilizing our Zacks ETF rank.
About the Zacks ETF Rank
This can easily be done by using the Zacks ETF Rank. This technique provides a recommendation for the ETF in the context of our outlook of the underlying industry, sector, style box, or asset class. Our proprietary methodology also takes into account the risk preferences of investors as well.
The aim of our models is to select the best ETFs within each risk category. We assign each ETF one of five ranks within each risk bucket. Thus, Zacks Rank reflects the expected return of an ETF relative to other ETFs with similar level of risk.
Using this strategy, we have found an ETF Ranked 2 or ‘Buy’ in the biotech industry which we have highlighted in greater detail below:
First Trust Amex Biotechnology Index Fund (FBT)
FBT tracks the NYSE Arca Biotechnology Index. The is an equal dollar weighted benchmark designed to measure the performance of a cross section of companies in the biotechnology industry that are primarily involved in the use of biological processes to develop products or provide services. (Medical Device ETFs: A Better Way to Play Health Care?).
This produces a product which is home to 20 stocks while charging investors a fee of 60 basis points. The fund has its asset base invested across all classes of the market spectrum, assigning 30% of the asset base to large caps, 29% to micro caps, 26% to mid caps and 15% to small caps.
A look at the style pattern reveals that the fund has a preference for growth stocks where it allocates 66% of the asset base while value securities have a share of just 10%.
This also implies that the fund prioritizes securities on the basis of earnings growth and tends to have little inclination for undervalued stocks or securities which trade below their intrinsic value. In terms of industrial exposure, 69% of the fund is allocated for biotechnology companies and 31% for pharmaceutical companies (read Which ETF Should You Buy This Holiday Season?).
Among individual holdings, the fund’s allocation appears to be concentrated in the top 10 holdings. The fund assigns just 54% of its asset base to the top 10 holdings while the rest is spread out among other companies. Top individual holdings include Sequenom Inc. (SQNM), BioMarin Pharmaceutical, Inc. (BMRN), and Dendreon Corporation (DNDN), comprising about 18.1% of the total.
With this relatively spread out nature, we believe that FBT could be a solid choice for investors. Biotech stocks seem well positioned in this type of market environment, and this highly ranked FBT could make for an interesting pick if you are looking to go past the Fiscal Cliff in U.S. markets to start 2013.
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