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Forget Big Pharma, It Is Time For A Biotech ETF

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Recent earnings reports from a few bellwethers in the pharmaceutical space suggest that more pain is likely ahead for the beleaguered industry. Both Pfizer (PFE - Free Report) and Eli Lilly (LLY - Free Report) managed to beat expectations for the latest quarter, but clearly competition from generics and a lack of new products in the pipeline are beginning to have a huge impact on securities in this space. In fact, in this the first quarter in which both PFE’s and LLY’s once blockbuster drugs were off patent, net income fell by 50% and 27% respectively, for the giants. This suggests that the only thing that kept these securities from tumbling was the incredibly low expectations that analysts have for the firms and that further weakness could be seen unless R&D efforts pay off soon.

Meanwhile, in the biotech space, the situation is much brighter thanks to strong sales for many of the industry’s top drugs. This is best evidenced by Biogen’s (BIIB - Free Report) recent surge in income thanks to its multiple sclerosis drugs, as well as an increase in revenues for Amgen although earnings did slump below estimates in a recent release but the firm did increase its guidance for the 2012 fiscal year (read Are Telecom ETFs In Trouble?).  

Additionally, the rather robust pipelines of many firms could also assist many biotechs in becoming takeover targets, either by larger biotechs or firms that are more in the pharma space.  According to recent reports, giants in the space such as the aforementioned PFE as well as Johnson & Johnson (JNJ) and Merck (MRK - Free Report) , combine to have more than $60 billion in cash on hand, meaning that a flurry of smaller biotech acquisitions shouldn’t be out of the question for these firms.  In fact, we are already starting to see this trend play out—at least from the biotech giants-- as Amgen recently announced plans to purchase Micromet while Celgene (CELG) revealed a deal to scoop up Avila Therapeutics for  $925 million, possibly foreshadowing a wave of mergers in the space which could boost stock prices of many of the smaller firms in the sector that have quality pipelines (see Three Low Beta Sector ETFs).  

In this space, investors currently have five choices from which to pick from. Although each of the funds offer quality levels of exposure to the space, there are a few key differences that investors should be aware of before making a play on this intriguing sector:

iShares NASDAQ Biotechnology ETF (IBB - Free Report)

This fund tracks the NASDAQ Biotechnology Index which consists of companies that are exposed to the sector and that trade on the NASDAQ market. The product currently consists of about 120 securities and charges investors 48 basis points a year in fees. Top holdings include Amgen (AMGN - Free Report) at 8.5% of the portfolio, Alexion (ALXN) at 6.5% and Celgene at 6.4%. Over the past fifty two weeks, the product has risen by 28.7% and has surged by 25.7% in the past three month period alone (read Which Auto ETF Should You Take For A Ride?).

PowerShares Dynamic Biotech & Genome Portfolio (PBE - Free Report)

For investors seeking greater exposure to the genome side of the market, PBE could make for an interesting pick. The fund tracks a slightly more ‘active’ index which looks to screen out some of the lowest rated stocks, giving the portfolio just 30 securities in total. Still, the product is pretty well diversified among individual securities as Life Technologies (LIFE) takes the top spot with 5.6% of the assets but Vertex (VRTX - Free Report) and Amgen each also comprise at least 5.2% of the fund as well. Longer term performance has been subpar for this small cap heavy fund in light of the recession but it has managed to turn things around recently, gaining 17.6% in the past quarter but just 8.1% in the past one year period. 

SPDR S&P Biotech (XBI - Free Report)

State Street’s entrant in the space is XBI, a fund that follows the S&P Biotechnology Select Industry Index. This benchmark produces a fund that holds just under 50 holdings while charging investors a pretty low 35 basis points a year in fees. Like many products in the space, this one is skewed towards mid and small cap securities, as XBI has an average market cap of just $7.4 million. Top holdings include a large number of these types of firms as Denderon (DNDN) takes the top spot but is closely followed by Regeneron Pharmaceuticals (REGN). XBI’s performance has been pretty solid over the past 52 weeks as the fund has gained just over 29.6% in the time period including a nearly 27.5% gain in the past quarter (read Time To Buy The Media ETF).

First Trust NYSE Arca Biotechnology Fund (FBT - Free Report)

For investors seeking a more a very pure play approach to the space, FBT could be an interesting choice. The fund tracks firms that are primarily engaged in the use of biological processes to develop products or services. With this tight focus, the fund only has 20 securities in its basket but charges investors 60 basis points a year in fees for its services. Thanks to the use of equal weighting, small caps play an outsized role in the fund and no one security takes up too much of the assets. In fact, the top three holdings make up roughly 6% each while every security in the top ten accounts for at least 4.8% of the assets.  Performance has been pretty solid in this fund too, as FBT rose by about 27.4% in the past quarter but has slumped from longer term metrics, gaining 8.4% in the past one year period (read Three Technology ETFs Outperforming XLK).

Market Vectors Biotech ETF (BBH - Free Report)

This former Merrill Lynch HOLDR recently underwent a conversion to become the Market Vectors Biotech ETF, tracking the Market Vectors US Listed Biotech 25 Index. Thanks to this, the product now charges investors 35 basis points a year in fees but is still seeing light volume post-conversion. Nevertheless, the product could see more of a tilt towards the large caps in the space and thus be an interesting play from that perspective. Top holdings include Amgen at close to 16.9% while Gilead Sciences (GILD - Free Report) and Celgene occupy roughly 10% and 9%, respectively. In terms of performance, direct comparisons are not really possible due to the conversion and the shifting benchmark, but investors should note that the product is up double digits since its conversion in late December including a 20.4% jump since the start of the year.

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Disclosure: Author holds a small position in PFE and PBE.

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