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Is iShares Nasdaq Biotechnology ETF a Buy?

Dan Caplinger, The Motley Fool

Investors seeking the fastest-growing companies in the stock market have often turned to the biotechnology sector for good investment prospects. From well-established giants in the biotech field to the latest up-and-coming players in the space, long-term returns for biotech stocks have generally been extremely strong.

For those who prefer not to try to pick individual stocks, exchange-traded funds can be a valuable alternative. In particular, the iShares Nasdaq Biotechnology ETF (NASDAQ: IBB) offers a diversified portfolio of biotech stocks that gives you complete coverage of the sector. Since going through a major downturn in 2015 and early 2016, the biotech sector has bounced back. With that in mind, let's take a closer look at the iShares biotech ETF to see whether it would make a smart buy right now.

Magnification of needle poking into cell.

Image source: Getty Images.

The basics of iShares Nasdaq Biotechnology ETF

The iShares biotech ETF has a structure that's familiar to anyone who invests regularly in exchange-traded funds. The ETF tracks an index of nearly 200 biotech and pharmaceutical stocks, with roughly 80% of assets dedicated to true biotechs and the rest split evenly between pharma and life sciences equipment and services providers. Top ETF holdings Biogen (NASDAQ: BIIB), Amgen (NASDAQ: AMGN), and Gilead Sciences (NASDAQ: GILD) make up a total of roughly 25% of the fund's assets.

The iShares biotech ETF comes with a cost structure that's fairly typical for a sector ETF from iShares. Investors pay an annual management fee of 0.46% of assets. Currently, iShares manages about $9.4 billion in assets within the fund.

How the ETF has fared over time

When you look at the iShares biotech ETF's long-term returns, they're very impressive. Over the past 10 years, the ETF has delivered average annual returns of nearly 16%. That's considerably stronger than the overall market, which despite having seen one of the most impressive bull markets in history has still returned an average of just 11% during the same period.

More recently, though, the iShares ETF has been more volatile. Shares plunged by roughly 35% to 40% between mid-2015 and early 2016, reflecting a massive change in sentiment for the industry. Political pressures stemming from high-profile price-gouging allegations from certain players in the pharmaceutical industry led to fears that greater regulation would make biotechs much less profitable. Although a typical number of drug approvals and mergers and acquisitions in the industry took place in that time frame, uncertainty still made investors nervous.

By 2017, some of those uncertainties facing biotech had been resolved. Although the incoming Trump administration made comments about continuing to push drug companies to keep prices down, explicit legislation implementing actual price controls failed to come about. With a weaker appetite for regulation, it seems unlikely that the current political situation in the federal government will lead to obstacles for the biotech industry in general. Stocks therefore started to recover much of their losses from previous years.

Is biotech a buy right now?

At this point, there are good reasons both favoring biotech and advocating for caution. On the positive side, biotech stocks in general continue to see substantial levels of development of new treatments, and there's been ample funding for the industry through both public stock offerings and private placements. Valuations for some of the biggest players in the space remain attractive, as ongoing efforts to create partnerships and other collaborative efforts reflect the opportunities that major biotech companies see. There are also some little-followed biotech stocks that have plenty of promise.

On the other hand, there are some signs of speculative excess. As has always been the case with biotech, some stocks have seen massive gains in short periods of time following good news, such as licensing deals with larger partners or favorable clinical trial results for lead compounds. Smaller companies are especially susceptible to sudden gains and can be vulnerable to equally large drops when things go badly.

Why iShares biotech ETF makes a good play

Even with concerns about frothiness in some parts of the sector, the primary advantage of iShares Nasdaq Biotechnology ETF is that it gives investors most of their exposure to biotech by holding industry giants. Those stocks generally haven't been frothy, and some have seen subpar returns for years as investors wait for them to capitalize more fully on their opportunities.

If you're excited about biotech, then the iShares Nasdaq Biotechnology ETF is worth a closer look. As a one-stop shop for biotech stock exposure, the ETF has given shareholders the returns they want with the protection that greater diversification can bring.

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Dan Caplinger has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Biogen and Gilead Sciences. The Motley Fool recommends Amgen. The Motley Fool has a disclosure policy.