Funds for a Sick Economy?

Overshadowed by gyrations in the credit, commodity, and energy markets, biotech has been a sleeper with positive returns. Market turmoil often leads to investors run for defensive plays such as health care, but biotech in some ways is the best of both worlds: It has growth opportunities that many other health-care stocks lack.

Today, I'm looking at two biotech mutual funds that are performance leaders in their category, both this year and over the past three years -- the ProFunds Biotech Fund (BIPIX) and the Rydex Biotech Fund (RYOIX). We'll see whether they're worth considering -- as long as you're willing to take on the risk of a narrowly focused investment.

Fund specifics
Although they have many differences, the funds so share three major holdings: Gilead (Nasdaq: GILD  ) , Amgen (Nasdaq: AMGN  ) , and Celgene (Nasdaq: CELG  ) . For ProFunds, these three holdings represent more than half of the index it tracks. Rydex, meanwhile, has about a quarter of its assets in those three stocks. Genentech (NYSE: DNA  ) , Myriad Genetics (Nasdaq: MYGN  ) , and Genzyme (Nasdaq: GENZ  ) are also common to both funds, albeit in smaller quantities.

The three-year returns for these two funds are extremely close, but so far this year, ProFunds is stomping on Rydex, with a 37% return compared with Rydex's 13%. That's happening in part because ProFunds routinely employs leveraged investment techniques to achieve its goal of daily investment results that correspond to 150% of the performance of the Dow Jones U.S. Biotechnology Index. This approach can magnify gains and losses and result in greater volatility in value. Rydex takes the more traditional long equity route.

Fund facts

Fund

3-Year Annualized Return

Net Expense Ratio

Total Assets as of 8/15/08

ProFunds

8.2%

1.56%

$32 million

Rydex

8.0%

1.39%

$128 million

Source: Morningstar.

Fund prospects and risks
Biotechnology's close link to medicine can make it a defensive bet in a weak economy. But there are also agricultural applications in biotech, such as genetically engineered crops and the red-hot biofuels area. And even if the commodities crunch continues, the momentum in alternative fuels may help support biotech companies. What's more, biotech companies have some resistance to an economic slowdown, since consumers need health care regardless of economic conditions. Some 60 million boomers are reaching their golden years -- that in itself is a long term argument for health care and the innovations that biotech can bring.

Yet biotech investing is not an easy way to play the market. It comes with significant volatility in returns, as well as regulatory uncertainty, such as when the FDA imposes additional burdens to approve drugs or even pulls existing products from the market.

Portfolio fit?
Biotech is a tough area for most investors to evaluate, because of the complexity of the products. As a result, many investors will be better served with a fund investment than by  seeking out individual stocks. Even then, with their narrow focus, biotech funds are suitable only for a small portion of most investors' portfolios. 

Both of these funds are expensive to invest in, with high expense ratios. A much friendlier alternative for your wallet is the SPDR Biotech ETF (AMEX: XBI  ) . With no minimum investment and a 0.35% expense ratio, the SPDR Biotech fund gets my vote for tracking the biotech sector.

Despite the outstanding returns that ProFunds Biotech has posted this year, don’t overlook that this fund has a very concentrated portfolio and uses leverage. Of these two funds, the Rydex Biotech fund may be more suitable for those with less tolerance for the volatility that a leveraged fund can experience.

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Fool contributor Zoe Van Schyndel now lives in the Seattle area, where she enjoys the coffee and the natural wonders. She owns none of the funds or securities mentioned in this article. Myriad Genetics is a Motley Fool Rule Breakers recommendation. Try any of our Foolish newsletter services free for 30 days. The Motley Fool has a disclosure policy.


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