Biotech investing is not for the faint of heart. The industry is chock-full of companies that don't even have revenue yet, let alone profits, which can lead to wild price swings. To make matters worse, it takes an average of more than a decade of research and development, costing an average of $2.6 billion, to get a single drug to market.Given those industry dynamics, many investors simply write off the entire sector as un-investable.
However, it's a mistake to simply ignore biotech completely, as the sector offers a fertile hunting ground for stocks that can offer life-changing returns. So what to do?
For investors who want some exposure to the space but don't want to worry about picking individual stocks themselves, buying into a biotech-focused exchange-traded fund can make a lot of sense. ETFs offer investors instant diversification at a low expense ratio. But with so many choices available, which biotech ETF is the right way to go?
The top three biotech ETFs by size are the iShares NASDAQ Biotechnology Index ETF (NASDAQ:IBB), the First Trust NYSE Arca Biotechnology Index Fund (NYSEMKT:FBT), and the SPDR S&P Biotech ETF (NYSEMKT:XBI).
Each of these funds has been around for years, and although they differ in some meaningful ways, each has simply smashed the returns of the S&P 500 over time:
Long-term charts are great for context, but they don't really give investors much information on which investment best suits their needs.
To figure that out, you need to crack each one open to get a better idea of how they differ. Lets do that now to see what we can learn:
|First Trust NYSE Arca Biotechnology||iShares Nasdaq Biotechnology||
SPDR S&P Biotech
|Total Assets:||$3.14 billion||$8.35 billion||$2.37 billion|
|Average Market Cap:||$9.1 billion||$20.1 billion||$1.9 billion|
|Price / Prospective Earnings:||24.63||22.29||24.28|
|Morningstar Rating:||4 stars||4 stars||2 stars|
Each of these ETFs offers its investors exposure to slightly different parts of the biotech world. To make things easy, let's break them down by risk to help determine which one is the better choice depending on what you are looking for in an investment.
Investors who are looking to gain access to the biotech sector while assuming the least amount of risk should consider investing in the iShares NASDAQ Biotechnology Index ETF, as that fund holds the largest number of companies overall and is focused on the larger companies in the space.
Its top five holdings include biotech blue chips like Amgen and Gilead, which constitute 43% of the fund's assets. With several of the big biotechs currently trading at below-market multiples, it's no surprise to see that the IBB has the lowest price-to-prospective-earnings ratio of the bunch.
Investors who are looking to wade a bit deeper into the biotech pool should give the First Trust NYSE Arca Biotechnology ETF a closer look. Although it holds the fewest number of companies among these three ETFs, it is more heavily weighted toward the mid-cap businesses in the space, which could give the fund more long-term upside potential, as medium-sized companies tend to have more room to run.
Its top five holdings include a few fast-growing companies like Alexion Pharmaceuticals and Regeneron, both of which are solidly profitable and growing quickly, though neither company could be called cheap. Still, I think this ETF's focus on mid-cap names could set it up nicely to outperform over the long-term.
Investors with a strong stomach for risk might want to consider the SPDR S&P Biotech. Although this fund holds over 100 companies, it is focused on the smaller-cap, early-stage end of the biotech spectrum. Nearly half the names in this ETF do not even have a drug on the market yet, so this fund remains highly speculative in its nature, which can clearly be seen in the firm's average market cap of only $1.9 billion.
The fund's top holdings include some exciting names like Five Prime Therapeutics and Juno Therapeutics, both of which have handily beaten the market since coming public, but the ETF is also equally weighted, so no single company exerts a huge influence over the fund.
Still, given the small-cap focus, this name may prove to be the most volatile of the group.
Brian Feroldi has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Celgene. The Motley Fool recommends Juno Therapeutics. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.