Biotechnology stocks are some of the riskiest companies to invest in.
When you think about it, there’s a pretty good reason – biotech companies invest millions to research and develop new drugs, which may never come to fruition. Even when they are successful, they still need prove the drug’s worth through trials and FDA approvals.
But when they are successful, the payback can result in exponential gains.
This risk is all the more reason to target a sector ETF rather than try and pick which company will develop the next great product.
The SPDR S&P Biotechnology ETF (XBI) is attractive to us because it is an “equal weight” fund, where stocks are weighted equally regardless of company size. This allows the investor to benefit from large gains made by smaller, riskier companies at the same rate as gains made by large companies.
Conversely, the fund will take a larger hit than other biotech ETFs should one of these smaller companies “bust.”
Taking a look at XBI’s 52-week chart below, the fund has been on an overall downward trend since mid-July 2015. You may remember at that time there was public controversy when Turing Pharmaceuticals increased the price of an HIV-treating drug called Daraprim from $13.50 to $750 per pill.
As a result, fairly or unfairly, the entire sector suffered from the public backlash.
Shortly after the 2016 New Year, XBI rapidly dropped below our Buy Threshold. However, it has held steady and trended slightly upward since early February.
Expert analysts claim that the industry is still sound, even though the sector was due for a correction even without the Turing controversy.
Of particular note, there is a critical need for effective cancer treatments, which many of the key biotech companies are investing significant research and development funds into.
From a long-term perspective, the outlook for this sector appears to be favorable.
With the ETF
- Still below the Buy Threshold and holding level,
- A high probability that many companies were unfairly punished for Turing Pharmaceutical’s actions, and
- Confidence in the long-term outlook for the industry,
we purchased shares of XBI in early April.