Managing biotechnology investment risk

Filed under: Biotech ETF

For the small investor, one of the most rewarding and consequently one of the riskiest investments in the stock market is to invest in small cap biotech companies. To be successful, you have to watch out for problems ranging from unpredictable regulatory activity to stock promoters and intermediaries inflating stock prices for personal gain and managements who would try and dilute the value of your shareholding just to stay in business. Because of the high volatility of the industry, you will also need to cope with strong emotions such as greed and fear.

However, you should be reassured that managing these risks is not rocket science and does not require advanced scientific knowledge or an inordinate amount of time and effort. In fact there are several common sense ways by which you can control the risk on your investment and separate the blockbusters from the trash in the world of biotechnology. These methods will also enable you to successfully overcome the pitfalls that you are likely to encounter and make it easier to pick quality stocks.

The first thing you should do is to stay with stocks that are owned by professional investors such as hedge funds. Institutional investors are thorough professionals and you can be sure they would have done their due diligence properly and research the prospects for the stock with a high degree of expertise and insight. Moreover, companies that have these kinds of shareholders will think a dozen times before doing something that will annoy their institutional investors. You can easily gather the details of the holdings from a number of sources.

You should look specifically for stocks where one or more professional investors own at least 5% of the stock. This is particularly important because the size of the position means that it cannot be liquidated in a hurry and regulation requires disclosures about changes in the size of this position. A 5% holding or more is a sign of long-term confidence in the prospects of the company because of the risk that the institutional investor is taking. This 5% holding is also important because you would find that, in many instances of “pump and dump” stocks, there was no single institutional holding of 5% or more. You should also handle any information that you might the other about companies without a 5% shareholder with more than the usual pinch of salt.

Take some time to get familiar with a few of the more respected institutional investors to guide you on your investment selection. Companies like Fidelity and Blackrock should instill a great deal of confidence in you but you should remember that because of the high-risk nature of biotech. Even the best institutional holding is no guarantee of success. All it does is improve the odds.

Having said this, the recommended route for the retail investor in biotechnology investment is to buy biotech Elf’s. Even without large amounts of capital, you get the benefits of diversification in a pool of different biotech stocks and improve the chance that one negative investment will be offset by positive moves in other investments. Because of the number of stocks in the pool, you also multiply your chances of picking a genuine ten bagger.

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