Biotech Funds: Enter With Care

Investors in biotech have the potential to reap tremendous rewards, but at the same time, the risk can be enormous -- sometimes in the same stock.

For example, an investor in Neurocrine Biosciences (NBIX) could have gotten into the stock below $5 in 1999. Neurocrine topped out at $73 in March of this year.

However, after the FDA failed to approve its insomnia treatment Indiplon and after partner Pfizer (PFE) walked away from the drug, Neurocrine's stock crashed, closing Wednesday at $9.23.

Mutual funds have long been a preferred method for investors to diversify their holdings, but there aren't too many biotech-oriented options. I found 10 funds that invest most of their assets in biotech. Several others have significant exposure to the sector but also invest heavily in medical devices, pharmaceuticals and health care stocks.

Christopher Davis, a fund analyst with Morningstar, suggests one of these broader health care funds for investors who want exposure to biotech. That way, a negative ruling by the FDA on a biotech stock doesn't wreck your portfolio. He points to (PRHSX)T. Rowe Price Health Sciences as one of his favorites. Of the fund's portfolio, 43% is invested in biotech stocks.

"It has a more aggressive approach and looks for faster-growing companies than some of its competitors," he said. As of March 31, four of its top five holdings were biotech -- Gilead Sciences (GILD), Amgen (AMGN), Genentech (DNA) and Cephalon (CEPH).

That's pretty much what you'll find in most biotech funds, and ETFs for that matter, says Davis, and that is why he recommends avoiding the sector-heavy funds to begin with.

"Chances are, you have exposure to these companies through your other mutual funds," he says. "Every large-cap growth fund owns Amgen and Genentech."

Plus, the mutual funds in the sector tend to be expensive. The ones that aren't appear to have managers with less-than-stellar track records.