Top ETF Picks For 2020: SPDR S&P Biotech ETF (XBI)

Biotech was one of the top performing sectors of the 2010s, but there's a clear bullish case for this group again in 2020.
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Note: This is just one in a series of articles talking about my top picks for 2020. I encourage you to check out my other top picks under the "Trade Ideas" tab and look for the "Top ETF Picks For 2020" heading!

For those of you waiting for a growth pick for 2020 after a series of defensive and safe haven picks, we’ve finally arrived at the one for you!

It’s not a particularly bold prediction to choose the ETF that’s been nearly the #1 performing non-leveraged fund over the past decade, but there’s still a pretty compelling bull case to make.

Biotech has enjoyed an extended period of positive drug development results and is enjoying something of a resurgence in M&A activity (for example, Bristol-Myers Squibb's acquisition of Celgene and Merck's purchase of ArQule) . 

Despite the massive rally in biotechs in Q4, the sector still trades at a 15% discount to the S&P 500, a bit of an anomaly considering that biotech earnings are expected to grow at double the rate of the S&P 500 over the next 3-5 years.

Biotech still trades at a premium to the market looking at both price-to-book ratios and price-to-cash flow ratios and will probably never be considered "cheap" using these metrics, but it's the sector's growth rate that is more compelling at the moment.

Another underappreciated benefit of biotech is that it has a low correlation to the broader market. Take a look, for example, at how the sector performed during the financial crisis.

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Biotechs outperformed large-caps by nearly 35% over the 3-year period around the financial crisis. Moreover, the S&P 500 dropped around 55% from peak to valley. Biotechs? They dropped just 37%. The sector's beta, which is typically in the 1.0 to 1.5 range, will always make the group riskier than average, but its correlation with the S&P 500 is regularly below 0.5.

That’s not to suggest that you should add biotechs to your portfolio as a defensive play in case of another crisis, but it does demonstrate that the sector has some real diversification benefits.

Why did I choose XBI over the more popular iShares Nasdaq Biotechnology ETF (IBB)? Quite simply, XBI is equal-weighted whereas IBB is market cap-weighted. IBB is very top-heavy in the industry’s biggest names, such as Gilead, Biogen and Amgen, exposing it to added risk if any one of those names struggles. XBI’s limited exposure to any single name helps reduce overall risk.

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