Some considerations in biotech ETF investments

Filed under: Biotech ETF

The past few years have undoubtedly been tough in the investing universe and many financial institutions that are household names have collapsed, had to be rescued or kept alive with emergency support from the government. Retail investors have been running scared and their priority has been to trade more safely and control risk while taking a hit on returns. This has resulted in a surge in the popularity of Exchange Traded Funds (ETF) where an investment represents a share in a pool of financial securities rather than exposure to a single stock or bond. The instant diversification and spreading of risk means that you now have Elf’s available that spanned the entire universe of financial securities and yet trade just like stocks.

It is now possible for you to invest in a chosen sector or industry by choosing the appropriate ETF and avoiding the risk associated with investment in a single stock or company. For instance, bio technology companies have traditionally been high-risk investments because a lot of them fall by the wayside and the drugs that they develop are subject to extended testing processes with no guarantee of success as well as FDA approvals. However the returns that you can obtain from a single successful blockbuster product developed by a company will far outweigh any losses that you might take. The ETF helps you to hedge your bets in what was essentially a highly volatile and unpredictable business.

However the risk/reward trade-off that is the reduction in return in return for the reduction in risk means that you should treat biotech ETF investments as long-term investments and not as short term trading opportunities. You will also have to forget about the home run that a successful single biotech company investment can provide with a blockbuster product. If you have an appetite for a higher level of risk, you can always choose an ETF where big and small companies are given equal weightage rather than an ETF where the asset allocation is weighted by market capitalization. This means that the really successful small company can boost your returns significantly.

The prices of biotech Elf’s can be impacted by the following factors:

• The pipeline for new products. Of necessity, biotech companies have to make huge investments in research and development often involving brand-new unproven technology. As a result, many of the products either simply do not make it to market or are not as commercially successful as the developers would have liked. As a result, the industry is heavily dependent on the handful of really successful products (often referred to as home runs or blockbusters) for generating significant revenues and profits. For example, stock prices of Human Genome Sciences rose almost 500% in a single week after they reported successful clinical trials of a new drug that they were developing.
• The environment for intellectual property protection. The biotech industry depends critically on protection for patents and intellectual property rights to protect their revenues and their profitability. Any regulatory or legal changes in this respect can have far ranging repercussions whether positive or negative
• Merger and acquisition activity. Biotech companies are prime acquisition targets especially if they have promising products in the pipeline. Large pharmaceutical companies are constantly looking for opportunities to expand their own product pipelines and have the financial resources to pay fancy prices should the need arise.

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