Not all biotechs are the same
Sophisticated biotech investors know that companies like Amgen (AMGN) and Vertex Pharmaceuticals (VRTX) are as different as night and day. Amgen is a product-selling, profitable biopharma company. Vertex is a money-losing, development-stage biotech company. No sane observer would call them comparable.
So why do most indexes and ETFs lump them into the same basket?
The obvious fundamental differences between biopharma and biotech companies demand different trading approaches. Investing in biotech companies requires broad diversification and strict attention to risk management. These companies can trade in a range for quite some time and then break forty, fifty, or even sixty percent overnight.
Despite their risk, biotech companies offer huge reward from both the short and long sides. The problem is that it’s often time consuming to acquire a broad basket of these stocks – and a broad basket is necessary to help ameliorate the risks of investing in biotech stocks. An index comprised of just biotech stocks solves that problem, providing instant diversification in one easily tradable package.
Current index offerings inadequate
There are two highly recognizable indexes out there claiming to represent the biotech sector. Neither does a good job because of their composition and skewed weightings.
Perhaps the most common is the AMEX Biotech Index (BTK). The BTK is a 20-company index composed of mostly biopharma companies. Weighting in the index ranges from 8.35% (Myogen) to 3.69% (ImClone). This index is clearly more a biopharma index than a biotech index.
The NASDAQ Biotechnology Index (NBI) is the other easily recognized index in the market segment. Currently numbering 164 companies, the NBI is touted as a good cross-section of biotech. Closer examination, however, reveals it is heavily skewed towards biopharma also.
The NBI is constructed using a modified capitalization-weighted method. This dramatically overweights the high-cap biopharmas over the real biotech companies in the index. While NASDAQ now offers an equal-weighted version of the index, over two-thirds of the NBI is comprised of biopharma or other companies not considered “biotech”.
Current ETF offerings are inadequate
If an investor’s goal is to access a basket of biotech stocks, they have no option but to construct their own basket. The BBH HOLDr mimics the BTK which, as we’ve already seen, is a biopharma index. The iShare IBB tracks the NBI, but its weighting towards the high cap biopharmas make it unsuitable for those interested in accessing only the biotech market.
We’ve examined all the other “biotech” ETFs, including recently released PowerShares offerings, and none captures the biotech space effectively. They are either too limited in scope, too heavily skewed in their weighting, or too burdened with biopharma companies.
The BSR Biotech Index TM
In response to this gaping hole in the biotech investment sector, Biotech Stock Research, LLC has developed the BSR Biotech Index TM. Our brand of biotech index focuses only on biotech stocks and provides each one an equal weighting within the index. In addition, our inclusion criteria assures investors in the BSR Biotech Index TM will be purchasing exposure to exactly what is advertised – biotech.
Here are the criteria for inclusion in the BSR Biotech Index TM:
- Must be traded on the AMEX, NASDAQ, or NYSE. No pink sheet listings
- The company’s market cap must be primarily related to a drug not yet approved by major regulatory agencies
- Any market cap is allowed
- Drug companies only. No service companies and no device-only companies.
By applying these ideas to the universe of nearly 1000 public healthcare segment stocks, BSR has created an index of about 250 biotechnology stocks. The BSR Biotech Index TM has been equal dollar weighted so any investor in it or an associated ETF does not have unexpected overexposure to a small number of stocks.