If you want to invest in biotech without taking on the risk of owning a single stock, you can choose between
iShares Nasdaq Biotechnology Index Fund
. Both have been around for several years and have cornered the market in the hearts and minds of ETF investors.
However, blind devotion to old standbys might lead to complacency and underperformance. The ETF industry is in its youth, so it's a good idea to learn about new products coming to the market. Enter the
PowerShares Dynamic Biotech and Genome Fund
, which is benchmarked to the Dynamic Biotechnology and Genome Intellidex (DZO).
The composition of the biotech PowerShares fund is much different from those of the biotech iShares and HOLDRs, which are two of the most flawed products out there. The Biotech HOLDRs has 41% in
and 25% in
. The biotech iShares has 15% in Amgen and cannot own Genentech because it trades on the
. The biotech PowerShares has roughly 4.25% in each name.
The biotech PowerShares is not so lopsided that one stock could truly damage the entire fund. The largest holding is
at 5.36%. There are eight stocks with a greater than 4% weight in the fund and six names weighted between 3% and 4% out of the 30 stocks in the biotech PowerShares.
Another point of differentiation is the genomics aspect of each fund. You might remember the mini genomics bubble of 2000, when stocks such as
went up tenfold in just a few months. Like the Internet, genomics will change our lives; unfortunately, like Internet stocks, genomics stocks had a ghastly blowup that is unlikely to be repeated in terms of magnitude anytime soon.
By my rough count, 18.7% of the biotech PowerShares is invested in genomics stocks, compared with less than 4% in the Biotech HOLDRs and biotech iShares. Keep in mind that these are rough numbers, but it is clear to me that the biotech PowerShares is much more focused on genomics than the other funds. This is an advantage if -- a big if, granted -- you buy into the genomics story.
A chart comparing the Dynamic Biotechnology and Genome Intellidex (the underlying index for the biotech PowerShares, which has more historical data than this new product), the Biotech HOLDRs and the biotech iShares reveals the extent to which the HOLDRs' outperformance has been all about Genentech. In the spring of 2003, the Biotech HOLDRs began its multiyear run. Because of the Biotech HOLDRs' permanently fixed basket approach, it has pulled away from the other two as Genentech has become a larger and larger holding.
I believe this makes the Biotech HOLDRs a wildly flawed product. An investor who really likes Genentech is being held back by the rest of the fund, while an investor who is single-stock averse has 41% in just one name.
The biotech iShares comes up short because it has had no lift at all from Genentech. The biotech PowerShares seems to offer the best exposure to the sector, both in terms of diversification and because it seems to have the fewest quirks of the three products.
Be aware that just because I believe the biotech PowerShares is better put together, it is not necessarily any less volatile than the stocks themselves. No matter how you access this subsector, it's going to be one of the more volatile areas of your portfolio.
One point that does not come up very often is how much biotech exposure a diversified portfolio should have. To answer that question, it makes sense to use the market's weight in the group as a benchmark. The
has 13.3% in health care overall. Of that 13.3% weight, 11.6% is in biotech, as measured by the
Healthcare Select SPDR
. The way the numbers work out, this means that a $100,000 portfolio would be equal to the S&P 500 in its biotech weighting if it had $1,542 in biotech. From there you could decide, on the basis of your own analysis and tolerance for volatility, whether to own more or less than the S&P 500 or any other benchmark.
Please note that due to factors including low market capitalization and/or insufficient public float, we consider the PowerShares Dynamic Biotech and Genome Fund to be a small-cap stock. You should be aware that such stocks are subject to more risk than stocks of larger companies, including greater volatility, lower liquidity and less publicly available information, and that postings such as this one can have an effect on their stock prices.
At the time of publication, Nusbaum was long iShares Nasdaq Biotechnology Index Fund and Gilead Sciences, although positions may change at any time.
Roger Nusbaum is a portfolio manager with Your Source Financial of Phoenix, Ariz., and the author of Random Roger's Big Picture Blog. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Nusbaum appreciates your feedback;
to send him an email.