Biotech ETFs: What Lies Ahead?

So far, it's been a good year for biotech stocks with the Nasdaq Biotechnology Index soaring 19.6% year to date. This is in sharp contrast to last year's performance when the Index was down 19.1% with several factors including the drug pricing controversy weighing on the sector.

2016 was disappointing from an R&D perspective as well with a fewer number of drugs managing to gain FDA approval and quite a few companies suffering from high-profile pipeline failures. Mixed results, slower-than-expected new product launches and increasing competition were some of the other challenges for the sector.  (Read: Time to Buy Global Low Volatility ETFs?)

However, ramp up in new product sales, R&D success and innovation, strong results, a higher number of FDA approvals and continued strong performance from key products are some of the factors that have helped the sector recover this year. Moreover, investors now seem more comfortable with the drug pricing scenario and are focusing more on the fundamentals of the sector.

Increasing Threat from Biosimilars

Although biosimilars are yet to pick pace, they remain a major threat for biotech stocks specially companies that are set to lose patent protection for major blockbuster drugs in the next few years. While a relatively new area, the market for biosimilars is huge and highly lucrative with several blockbuster biologics including Humira and Lantus slated to lose patent protection by 2020. Biosimilars are expected to reduce healthcare costs and provide a large number of patients with access to much needed biologic treatments. Biosimilars are also gaining acceptance across formularies.

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 and Remicade biosimilars alone represent potential savings of more than $22 billion.

Mergers and Acquisitions (M&As) Yet to Pick Pace

Although expectations were high that M&A activity would pick up in 2017, this did not happen. While several small deals were announced, big-ticket M&A activity was more or less limited with major acquisition news including Johnson & Johnson's $30 billion acquisition of Actelion and Gilead's $11.9 billion acquisition of Kite. (Read: 7 Top-Ranked Tech ETFs on Unstoppable Rally)

The sector will receive an additional boost if more M&A deals are announced, though companies are likely to adopt a "wait and see" stance as they await more clarity on the drug pricing situation and tax reforms. Another major deterrent could be high valuations with companies remaining wary of bidding wars leading to over-priced deals.

Higher Number of Drugs Approved So Far in 2017

So far in 2017, the FDA has granted approval to 34 novel drugs, surpassing last year's total tally of 22. Key approvals in the biotech sector this year include Gilead's Yescarta (CAR-T therapy for certain types of large B-cell lymphoma) and Vosevi (hepatitis C virus), Puma's Nerlynx (to reduce the risk of breast cancer returning), Regeneron/Sanofi's Kevzara (rheumatoid arthritis) and eczema treatment, Dupixent, TESARO's PARP inhibitor, Zejula and BioMarin's Brineura (treatment of a specific form of Batten disease) among others. Quite a few of these drugs have blockbuster potential.

The FDA is working on streamlining the development process for drugs for rare diseases as well as for targeted cancer therapies. The agency is also working on clearing up a backlog of orphan drug applications. (Read: Top Ranked Tech ETFs for Long Term Investors)

Innovative Pipelines & Catalysts

Biotech companies continue to work on bringing innovative new treatments to market, and there could be significant catalysts in the coming quarters in the form of important new product approvals as well as major data read-outs especially in key therapeutic areas like immuno-oncology, Alzheimer's, central nervous system disorders, and immunology/inflammation.

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 February 2001 by BlackRock Investments LLC, tracks the Nasdaq Biotechnology Index. The fund mainly covers biotech stocks (81.9%) with pharma accounting for 9.3%. The top 3 holdings include Amgen (8.4%), Biogen Inc. (8.28%) and Gilead Sciences, Inc. (7.85%). The total assets of the fund as of Oct 30, 2017 were $9.65 billion representing 159 holdings. The fund's expense ratio is 0.47% while dividend yield is 0.22%. The trading volume is roughly 1,268,319 shares per day.

SPDR S&P Biotech ETF (XBI)

XBI, launched in January 2006 by State Street Global Advisors, tracks the S&P Biotechnology Select Industry Index. The fund covers health care stocks only. Key holdings include Juno Therapeutics, Inc. (2.61%), Sarepta Therapeutics (2.51%), and Exelixis, Inc. (2.42%). The total assets of the fund as of Oct 30, 2017 were $4 billion representing 102 holdings. The fund's expense ratio is 0.35% while dividend yield is 0.22%. The trading volume is roughly 4,782,719 shares per day.

First Trust NYSE Arca Biotech ETF (FBT)

FBT, launched in June 2006 by First Trust Advisors, tracks the NYSE Arca Biotechnology Index. The top 3 holdings include Alnylam Pharmaceuticals, Inc. (3.68%), Juno Therapeutics, Inc. (3.64%), and Neurocrine Biosciences, Inc. (3.61%). The total assets of the fund as of Oct 27, 2017 were $1.2 billion representing 30 holdings. The fund's expense ratio is 0.56% while dividend yield is nil. The trading volume is roughly 33,108 shares per day.

VanEck Vectors Biotech ETF BBH

BBH, launched in December 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 (11.62%), Celgene Corporation (11.26%) and Gilead Sciences Inc. (11.18%). The total assets of the fund as of Oct 30, 2017 were $668.8 million representing 25 holdings. The fund's expense ratio is 0.35% while dividend yield is 0.2%. The trading volume is roughly 43,186 shares per day.

PowerShares Dynamic Biotech & Genome ETF (PBE)

PBE, launched in June 2005 by Invesco PowerShares, tracks the Dynamic Biotech & Genome Intellidex Index. The top 3 holdings include Illumina, Inc. (5.31%), Biogen (5.29%), and Gilead Sciences, Inc. (5.11%). The total assets of the fund as of Oct 30, 2017 were $237 million representing 31 holdings. The fund's expense ratio is 0.58% while dividend yield is 0.84%. The trading volume is roughly 13,247 shares per day.

Conclusion

Although the sector may face some volatility due to the drug pricing issue, pipeline success in innovative and important therapeutic areas, cost-cutting, share buybacks, new products, increased pipeline visibility and appropriate utilization of cash should help maintain investor confidence in this sector. 

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