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Time to Buy Biotech ETFs?

Zacks Equity Research

2016 was a tough year for biotech stocks with the sector facing a lot of criticism for rising drug prices. Although shares did rally post-election in November on hopes that drug pricing would not be a key focus area under a Donald Trump presidency, the rally turned out to be short-lived following the President’s views regarding drug pricing. Trump made it clear that he does not like what happened to drug prices and he will bring them down.

Drug pricing was not the only issue that impacted the sector last year -- 2016 was also disappointing from an R&D perspective with a fewer number drugs managing to gain FDA approval. There were some high-profile pipeline failures as well. Other factors that weighed on the sector include mixed results, slower-than-expected new product launches and increasing competition.

The impact of these issues resulted in the NASDAQ Biotechnology Index declining 19.1% in 2016. However, the sector is showing signs of recovery this year with the index gaining 12.4%year-to-date (YTD). (Read: Top-Ranked ETFs That Crushed S&P 500 in the Bull Market)

Drug Pricing Will Remain a Headline Risk

With drug pricing being a populist issue, it looks like the spotlight will remain on rising drug prices in 2017 as well. According to the Jan 2017 Kaiser Health Tracking poll, affordability of prescription drugs remains at the top of the public’s priority list for the President and Congress -- focus should be on ensuring the affordability of high-cost drugs to people who need them and taking steps to lower prescription drug prices.

President Trump’s recent tweet that he is “working on a new system where there will be competition in the Drug Industry” and “pricing for the American people will come way down” will keep the biotech industry on edge. While it is clear that the government intends to address the drug pricing issue, there is no clarity on what steps will be taken.

Biosimilars Pose a New Threat

Another challenge being faced by the sector is the recent entry of biosimilar competition in the U.S. 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. (Read: Trump’s Defense Spending Plans Make These ETFs Buys Again)

Deals to Pick Pace?

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.

Given the possibility of repatriation of funds, chances are that M&A activity will pick up as the year progresses -- 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: Play These Stocks & ETFs If Fed Acts in March)

Companies with innovative technologies and pipelines are highly sought after. Niche disease areas like nonalcoholic steatohepatitis (NASH), immuno-oncology and multiple sclerosis are in demand. Treatments for orphan diseases are also much sought after with quite a few deals being signed in these areas.

New Products Should Gain Traction

Highly-awaited new products that gained approval over the last couple of years should contribute significantly to revenues. The FDA approved 22 new drugs in 2016 including Exondys 51 (Duchenne muscular dystrophy), Epclusa (hepatitis C virus), Ocaliva (rare, chronic liver disease), Zinbryta (multiple sclerosis), and Venclexta (chronic lymphocytic leukemia in patients with a specific chromosomal abnormality) among others. The agency also expanded the label of cancer drugs like Kyprolis and Imbruvica.

Meanwhile, so far in 2017, the FDA has approved 5 new drugs including Trulance (treatment of chronic idiopathic constipation in adults) and Parsabiv (treatment of secondary hyperparathyroidism in adult patients with chronic kidney disease undergoing dialysis).

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 (81.6%) with pharma accounting for 10.8%, life sciences tools & services for 7.3%, Health care technology for 0.1%, Health care equipment for 0.11% and Health care supplies for 0.07%. The top 3 holdings include Amgen Inc. (9.23%), Celgene Corporation (7.72%) and Biogen Inc. (7.42%). The total assets of the fund as of Mar 7, 2017 were $8.38 billion representing 162 holdings. The fund’s expense ratio is 0.47% while dividend yield is 0.16%. The trading volume is roughly 1,491,728 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 ARIAD Pharmaceuticals, Inc. (3.98%), Clovis Oncology, Inc. (3.76%), and ACADIA Pharmaceuticals Inc. (2.74%). The total assets of the fund as of Mar 8, 2017 were $2.9 billion representing 88 holdings. The fund’s expense ratio is 0.35% while dividend yield is 0.21%. The trading volume is roughly 4,427,722 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 Kite Pharma, Inc. (4.77%), Alnylam Pharmaceuticals, Inc. (3.98%) and Nektar Therapeutics (3.77%). The total assets of the fund as of Mar 7, 2017 were $902 million representing 30 holdings. The fund’s expense ratio is 0.55% while dividend yield is nil. The trading volume is roughly 44,417 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. (12.13%), Celgene Corporation (10.73%) and Gilead Sciences Inc. (10.72%). The total assets of the fund as of Mar 8, 2017 were $702.5 million representing 26 holdings. The fund’s expense ratio is 0.35% while dividend yield is 0.21%. The trading volume is roughly 50,198 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 Incyte Corporation (5.38%), Vertex Pharmaceuticals Inc. (5.19%), and Regeneron Pharmaceuticals, Inc. (5.1%). The total assets of the fund as of Mar 8, 2017 were $245.6 million representing 31 holdings. The fund’s expense ratio is 0.50% while dividend yield is 0.34%. The trading volume is roughly 27,517 shares per day.

Conclusion

Although it may take a while for the dust around the drug pricing issue to settle down, pipeline success in innovative and important therapeutic areas, cost-cutting, share buybacks, new products, increased pipeline visibility and appropriate utilization of cash should help restore investor confidence in biotech stocks.

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ISHARES NDQ BIO (IBB): ETF Research Reports
 
FT-AMEX BIOTEC (FBT): ETF Research Reports
 
SPDR-SP BIOTECH (XBI): ETF Research Reports
 
PWRSH-DYN BIO (PBE): ETF Research Reports
 
VANECK-BIOTECH (BBH): ETF Research Reports
 
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