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Falling Correlations Goods News For Biotech ETFs


Finding better options among sector funds than biotechnology ETFs over the past year is no easy task. Over that time, the iShares Nasdaq Biotechnology Index Fund (IBB) , the largest biotechnology ETF by assets, is up 46.5% and it is not even the best performing ETF tracking the sector. In the same 12-month period, the S&P 500 is up just under 28%.

There are obvious reasons why IBB and rival biotech ETFs have been stellar performers, including the Food & Drug Administration picking up the pace of new drug approvals and speculation of increased mergers and acquisitions activity. [More Deals Could Boost Biotech ETFs]

Another reason the sector has performed well is equally as important as those factors, though perhaps not discussed as much. That being low correlations. Over the past five years, IBB has a correlation of 0.71 to the iShares Core S&P 500 ETF (IVV) . That level of correlation is high, though not excessively so. It does not tell the entire story, either. [Positive Prognosis For Biotech ETFs]

With IBB and other biotech ETFs, there are two other crucial factors to consider. First, the sector’s correlation to U.S. stocks has been dwindling. Second, using IBB as just one example, investors will find biotech’s correlations to international equities are not significant. That highlights biotech’s durability in the face of global macroeconomic headwinds.

For example, over the past five years IBB’s average correlation to the iShares MSCI Emerging Markets Index Fund (EEM) and the iShares S&P Europe 350 Index Fund (IEV) is 0.62, according to iShares data.

The three-year correlations of IBB to the aforementioned broader market ETFs are modestly higher, but the fund’s level of intimacy to global markets in particular plunges when evaluated on more recent time frames. Going from April 30, 2012 to April 30, 2013, IBB had a correlation of 0.29 to EEM and 0.4 to IEV. Since the start of 2012, the largest biotech ETF has correlations of just 0.25 and 0.38 to EEM and IEV, indicating that while biotech is not usually considered a docile sector, it has provided some shelter from storms in global financial markets.

In the case of IBB, the ETF is arguably not as volatile as some investors may believe it is. The fund has a beta of just 1.05 against the S&P 500 and a three-year standard deviation of 17.43%, according to iShares data.

EEM’s beta is only modestly higher, but its three-year standard deviation trumps IBB by over 400 basis points. IEV is, not surprisingly, an even more volatile offender with a beta of 1.45 and a three-year standard deviation north of 22%.

iShares Nasdaq Biotechnology Index Fund

ETF Trends editorial team contributed to this article.

Full disclosure: Tom Lydon’s clients own EEM.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.