A Better Way to Invest in Biotech?

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With the market down so much, even losing funds look good if they haven't lost very much. The Biotech HOLDR (NYSE: BBH) fund, for instance, has managed to eke out relatively good returns, drawing investor interest. Still, this is not your typical portfolio and should be looked at very carefully before dipping your toe in.

Fund specifics
HOLDRs enable investors to purchase a slice of the market in a number of specific sectors, from broadband companies to regional banks. Structured as a trust, the Biotech HOLDR holds common stock of companies in the biotechnology industry.

Unlike some sector exchange-traded funds (ETFs) that are well-diversified with dozens of securities, Biotech HOLDR has nearly 95% of its assets in just five stocks: Genentech (NYSE: DNA), Amgen (Nasdaq: AMGN), Gilead Sciences (Nasdaq: GILD), Biogen Idec (Nasdaq: BIIB), and Genzyme (Nasdaq: GENZ). Investors also have direct ownership of the underlying stocks. That means dividends are paid directly, resulting in numerous tax reporting obligations. There are no management fees, but there are transaction costs and an annual custody fee of $0.08 per HOLDR share. 

Fund facts

• Year-to-Date Return: 2.5%
• Expense Ratio: none; $0.08/share custody fee
• Assets: $1.2 billion 

Fund prospects and risks
A HOLDR is a basket of stocks just like an ETF. But there the similarity ends, as each HOLDR is a static portfolio that doesn't change over time. The HOLDR is unmanaged and its component stocks do not vary. This is very different from most ETFs, which track indexes that adjust periodically due to rebalancing. If a stock is acquired, the index will often replace it, but the HOLDR will remove it and not replace it.

That means that over time, the HOLDR's portfolio can become more and more concentrated. Investors look to ETFs for their diversification benefits, yet with Biotech HOLDR, you are really not getting that benefit.

Portfolio fit?
With a new president, there's potential for changes to the American health-care system. So investors should monitor the mood in Washington and make sure their portfolios are optimally positioned for any changes.

But remember that HOLDRs may not be the best tool for biotech investors. Don't get fooled into thinking this is just another sector ETF, as its unique structure makes it more like a concentrated five-stock fund. That level of concentration brings an unusually high degree of stock-specific risk, which most investors don't want. Although the strong performance of those five biotech stocks has led to good returns for Biotech HOLDR, it requires you to put your eggs into a pretty small basket.

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