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ETF News And Commentary

Biotech stocks have been under intense pressure for more than a year now with sector-specific issues like increasing political and media focus on high price tags for new drugs and the changing competitive scenario weighing on the sector.

However, the sector’s fundamentals remain strong -- mergers and acquisitions (M&As), product approvals and positive data flow should act as catalysts.

Drug Pricing to Remain in Focus

Although the biotech sector had reacted favorably to the surprise win of Donald Trump in the Presidential election, investors were in for a rude shock with the President-elect recently saying that he does not like price increases. (Read: Trump Attacks Biotech & Pharma—ETFs Bleed)

Shares of pharma and biotech companies had surged after election results on the expectation that the drug pricing controversy would take a backseat. The general opinion was that a Hillary Clinton win would have been a negative for drug stocks given her frequent rhetoric on rising drug prices and her plans to address the excessive price hikes of treatments that have been available for years and to lower drug prices for all Americans.

Trump, on the other hand, had not been so vocal about drug pricing though he did call for price transparency from all healthcare providers and drug re-importation.

However, the post-election relief rally turned out to be short-lived with Trump saying that his intentions may have been misread by some stock analysts. In an interview with TIME magazine, which has named him “2016 Person of the Year”, Trump said that his goal has not wavered -- he does not like what happened to drug prices and he will bring down drug prices.

With drug pricing being a populist issue, it looks like the spotlight will remain on rising drug prices. According to the Oct 2016 Kaiser Health Tracking poll, dealing with the high price of prescription drugs topped the public’s list for healthcare priorities. Most said that ensuring that high-cost drugs for chronic conditions like HIV, hepatitis, mental illness and cancer, are affordable should be a top priority along with taking steps to lower the prices of prescription drugs.

In this scenario, the drug pricing issue is not likely to die down easily and drug companies may find it a bit difficult to justify their high prices by citing the years and funds that go into bringing new treatments to market and the need to invest in R&D to bring additional treatments to market. (Read: 6 Biggest ETF Stories of 2016 Worth Watching in 2017)

Biosimilars Gaining Importance

Since the FDA approval of the first biosimilar in the U.S. (Sandoz’s Zarxio – a biosimilar of Amgen’s Neupogen) last year, this area is fast gaining importance with a lot of companies working on bringing biosimilars of blockbuster biologic treatments to market.

Pfizer and Celltrion’s biosimilar version of Johnson & Johnson’s blockbuster drug Remicade and biotech giant Amgen’s biosimilar version of AbbVie’sHumira both gained approval this year.

Biosimilars should cut healthcare costs and provide a large number of patients with access to much needed biologic treatments. According to information provided by Express Scripts, about $250 billion could be saved in the next decade (2014 – 2024) if biosimilars for 11 products including Neupogen, Avastin, Epogen, Humira, Neulasta, Remicade and Rituxan are approved. According to the company, Neupogen biosimilars alone represent potential savings of about $5.7 billion.

Deals to Continue

Licensing agreements and deals including those with opt-in arrangements should continue being signed with immuno-oncology remaining a favorite area. Moreover, major biotech and pharma companies should gain from Trump’s proposed tax plan and proposal to repatriate corporate profits held offshore at a one-time tax rate of 10%.

Given the possibility of repatriation of funds, chances are that M&A activity will pick up -- big companies with deep pockets often look to replenish and boost their pipelines as well as portfolios by acquiring companies with innovative pipelines and technology. Meanwhile, small bolt-on acquisitions will continue. (Read: Can Q4 Earnings Revitalize Healthcare ETFs?)

New Products Should Gain Traction

Highly-awaited new products that gained approval last year should contribute significantly to revenues. Some of the important new product approvals include cystic fibrosis treatment, Orkambi, heart failure treatment, Corlanor, PCSK9 inhibitors – Repatha and Praluent, and Genvoya (HIV).

Meanwhile, so far in 2016, the FDA has approved 20 new drugs including Exondys 51 (Duchenne muscular dystrophy), Epclusa (HCV), Ocaliva (rare, chronic liver disease), Zinbryta (multiple sclerosis), and Venclexta (chronic lymphocytic leukemia in patients with a specific chromosomal abnormality) among others. The FDA also expanded the label of cancer drugs like Kyprolis and Imbruvica.

ETFs in Focus

Highlighted below are some biotech ETFs - ETFs present a low-cost and convenient way to get a diversified exposure to the sector.

iShares Nasdaq Biotechnology (IBB)  

IBB, launched in Feb 2001 by BlackRock Investments LLC, tracks the Nasdaq Biotechnology Index. The fund mainly covers biotech stocks (81.9%) with pharma accounting for 10.6%, life sciences tools & services for 6.9%, Health care technology for 0.2%, Health care equipment for 0.1% and Health care supplies for 0.1% The top 3 holdings include Amgen Inc. (8.31%), Gilead Sciences Inc. (8.07%) and Celgene Corporation (7.93%). The total assets of the fund as of Dec 19, 2016 were $7.74 billion representing 164 holdings. The fund’s expense ratio is 0.47% while dividend yield is 0.16%. The trading volume is roughly 1,258,856 shares per day.

SPDR S&P Biotech ETF (XBI)

XBI, launched in Jan 2006 by State Street Global Advisors, tracks the S&P Biotechnology Select Industry Index. The fund covers health care stocks only. The top 3 holdings include Ionis Pharmaceuticals, Inc. (3.65%), Tesaro, Inc. (3.59%), and Incyte Corporation (3.13%). The total assets of the fund as of Dec 19, 2016 were $2.6 billion representing 84 holdings. The fund’s expense ratio is 0.35% while dividend yield is 0.49%. The trading volume is roughly 5,208,449 shares per day.

First Trust NYSE Arca Biotech ETF (FBT)

FBT, launched in Jun 2006 by First Trust Advisors, tracks the NYSE Arca Biotechnology Index. The top 3 holdings include Ionis Pharmaceuticals, Inc. (5.65%), United Therapeutics Corporation (4.14%) and Seattle Genetics, Inc. (3.89%). The total assets of the fund as of Dec 16, 2016 were $836 million representing 30 holdings. The fund’s expense ratio is 0.55% while dividend yield is nil. The trading volume is roughly 83,094 shares per day.

VanEck Vectors Biotech ETF (BBH)

BBH, launched in Dec 2011 by Van Eck, tracks the Market Vectors US Listed Biotech 25 Index. The fund covers health care stocks. The top 3 holdings include Amgen Inc. (11.03%), Celgene Corporation (10.9%) and Gilead Sciences Inc. (10.88%). The total assets of the fund as of Dec 19, 2016 were $566 million representing 25 holdings. The fund’s expense ratio is 0.35% while dividend yield is 0.31%. The trading volume is roughly 42,529 shares per day.

PowerShares Dynamic Biotech & Genome ETF (PBE)

PBE, launched in Jun 2005 by Invesco PowerShares, tracks the Dynamic Biotech & Genome Intellidex Index. The top 3 holdings include Amgen Inc. (5.26%), Gilead Sciences Inc. (5.1%), and Alexion Pharmaceuticals, Inc. (4.97%). The total assets of the fund as of Dec 19, 2016 were $240.7 million representing 31 holdings. The fund’s expense ratio is 0.50% while dividend yield is 1.11%. The trading volume is roughly 51,179 shares per day.

Conclusion

“High risk and high returns” is a term often associated with the biotech sector. Biotech drugs, which are developed through a biological process/system or by using living organisms, require a lot of investment. The drugs are complex in nature and take several years to develop. Companies which hit the bull’s eye become overnight success stories with shares even doubling or tripling on positive news. However, negative outcomes have an equally strong effect on the shares and failure may very well spell doom for these companies.

Strong pipelines, innovative treatments, impressive results, growing demand for drugs especially for rare-to-treat diseases, an aging population and increased health care spending should support growth in this sector.

On the flip side, the high cost of treatments, pricing controversies and the threat of biosimilars remain dampeners for this high risk-high return sector.

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