Investing in Biotech ETFs

In this blog article, we’ll explore what biotech ETFs are, how to choose an ETF that aligns with your goals and risk tolerance, steps in buying a biotech ETF, and the best performing biotech ETFs available today.

What is a biotechnology ETF?

A biotechnology exchange-traded fund (ETF) is a type of investment fund that holds shares of multiple companies in the biotechnology sector. These companies combine biology with technology to develop products like new drugs, diagnostic tools, or genetic therapies.

Biotech ETFs trade on major stock exchanges, just like individual stocks. But instead of investing in one company, a biotech ETF spreads the investment across a basket of biotech firms. This helps reduce risk by diversifying exposure across the entire sector.

How biotech ETFs work

Most ETFs are designed to track a specific index, sector, or commodity. In the case of biotech ETFs, companies might include those involved in areas like genomics, molecular biology, genetic engineering, or clinical drug trials. Some biotech ETFs are passively managed and follow a broad benchmark, while others are actively managed by fund managers who choose stocks based on research or market trends.

Unlike mutual funds, ETFs trade throughout the day and investors can buy or sell shares anytime the market is open. They also tend to have higher daily liquidity and lower expense ratio compared to mutual fund shares, making them popular amongst individual investors.

ETFs have a net asset value (NAV), which represents the value of its underlying holdings at the end of the trading day.

Types of biotech ETFs

Different types of biotech ETFs include:

• Small-cap biotech ETFs: These focus on emerging biotech firms with smaller market capitalisations. These companies might be in early stages of drug development and can be more volatile, but also offer high growth potential.
• Pharmaceutical sector: These are broader funds that include biotech firms as well as large drug manufacturers.
• Leveraged biotech ETFs: These use financial instruments to amplify returns. For example, a 3x leveraged ETF aims to deliver three times the daily performance of its underlying index, both risk and returns are increased by 3x. These ETFs carry higher risk and are generally used for short-term trading.

Understanding biotech ETF holdings

The companies biotech ETFs invest in are referred to as holdings. These might be large, well-established pharmaceutical firms like AstraZeneca or smaller biotech startups working on early-stage drug developments. Each company in the ETF is given a weight, which determines how much of the fund is allocated to that stock. These weights are based on factors like the company’s market value and position within the sector.

For example, Vertex Pharmaceuticals Inc. makes up about 8.7% of the iShares Nasdaq Biotechnology ETF (IBB) at the time of writing, making it the fund’s largest holding. Looking at an ETF’s holdings and how they’re weighted can help investors get a clear picture of where their money is going.

Most biotech ETFs include a mix of large-cap biotech and pharmaceutical companies, mid- and small-cap biotech firms, and research-driven companies. The exact mix of these holdings will depend on the ETF’s strategy – some aim for established companies with low volatility while others focus on startups with high risk and high reward potential. Reviewing these holdings is the best way to make sure an ETF aligns with your risk tolerance and investment goals.

How to choose a biotech ETF

Here are some things to consider when choosing a biotech ETF:

• Top holdings & weighting: Start by reviewing the ETF’s top holdings. Are they dominated by large-cap pharma firms or smaller biotech startups? Large companies tend to offer more stability while smaller firms might offer higher growth potential (along with higher risk).
• Expense ratio: This is an annual fee charged by the ETF. Biotech ETFs tend to have slightly higher expense ratios due to their specialised focus, so it’s a good idea to compare fees across similar funds.
• Fund strategy: There are two types of ETFs: passive ETFs track an index of biotech companies while active ETFs rely on managers to pick stocks. These usually come with higher fees.

Like all other investments, it’s important to make sure a biotech ETF matches your risk tolerance, investment goals, and costs.

How to buy biotech ETFs

Ready to invest in a biotech ETF? Here’s a step-by-step guide on how to get started:

1. Open a brokerage account

The first step is to open a brokerage account. Most major online brokers today offer low or no account minimums and commission-free ETF trading.

2. Do your research

Once your account is set up, start doing some research. Consider what kind of exposure you’re looking for with your ETF:

• Do you want to go for high-growth/higher risk, small-cap biotech companies?
• Do you prefer the stability of large pharmaceutical firms?

This research will help you understand your risk tolerance and guide your ETF search.

3. Compare ETFs

Use your broker’s ETF screener or other tools to compare different options. Things to consider in this step are top holdings and weightings, market cap mix, expense ratios, and fund strategy.

If you’re interested in a specific company, you can also use a stock exposure tool to see which ETFs hold that company’s stock.

4. Execute your trade

Once you’ve chosen a biotech ETF that fits your goals, it’s time to make the trade. Choose how many shares you want to buy and submit the order through your brokerage account.

Popular biotech ETFs

To help you get started on your search, we’ve rounded up some of the top-performing biotech ETFs below.

VanEck Biotech ETF (BBH)

• Expense ratio: 0.35%
• Strategy: Tracks the MVIS U.S. Listed Biotech 25 Index
• Top holdings: Amgen, Gilead Sciences, Regeneron.

BBH offers exposure to the largest and most liquid biotech firms in the U.S. Since its launch in 2011, the ETF has delivered an annualised return of 13.5%. Its narrow, large-cap focus makes it more stable than ETFs investing in smaller companies.

iShares Biotechnology ETF (IBB)

• Expense ratio: 0.45%
• Strategy: Tracks the NYSE Biotechnology Index
• Top holdings: Amgen, Vertex, Regeneron, Gilead, Moderna.

IBB is one of the most popular biotech ETFs. Like BBH, it favours large, established companies. IBB has 215 holdings and is known for being tax-efficient, with a 0.3% 30-day SEC yield.

Invesco Nasdaq Biotechnology ETF (IBBQ)

• Expense ratio: 0.19%
• Strategy: Tracks the Nasdaq Biotechnology Index
• Top holdings: Amgen, Vertex, Regeneron, Gilead, Moderna.

IBBQ has nearly identical holdings to IBB, but at a much lower cost. This makes it a smart option for long-term investors wanting to manage fees. IBBQ also tracks a different index to IBB, which means it can be used in tax-loss harvesting strategies.

SPDR S&P Biotech ETF (XBI)

• Expense ratio: 0.35%
• Strategy: Tracks the S&P Biotechnology Select Industry Index
• Holdings: 130+

Unlike other ETFs that give more weight to large firms, XBI uses an equal-weight approach that spreads its allocations more evenly across holdings. This boosts exposure to small and mid-cap biotech stocks compared to other ETFs, making XBI more volatile but also increasing the potential for reward for risk-tolerant investors.

WisdomTree BioRevolution Fund (WDNA)

• Expense ratio: 0.45%
• Strategy: Tracks the WisdomTree BioRevolution Index
• Top holdings: Natera, Twist Bioscience, Novozymes, Blueprint Medicines

WDNA aims to capture the growth of biotech megatrends while maintaining global exposure (around 18% of the portfolio is based outside of the U.S.) It avoids many of the top holdings seen in other funds, making it a potential complement to US-focused biotech ETFs.

Direxion Daily S&P Biotech Bull 3X Shares (LABU)

• Expense ratio: 0.96%
• Strategy: 3x daily leverage on S&P Biotechnology Index
• Top holdings: Neurocrine, Abbvie, Gilead, Biomarin, Utd Therapeut

LABU is designed for traders who want amplified exposure to daily biotech movements. Because of the compounding risk of leverage, this fund isn’t meant for long-term investing. Instead, it’s used for short-term bullish trades only. LABD is its counterpart, offering 3x inverse exposure for bearish strategies.

ESG scores

ESG stands for Environmental, Social, and Governance. ESG scores are used to measure how well a company (or an ETF’s portfolio of companies) performs in key areas:

• Environmental: How a company manages its impact on the environment, such as carbon emissions or waste reduction
• Social: How a company treats employees, supports communities, and manages customer relationships
• Governance: How a company is run (e.g. board diversity, executive pay, transparency, ethics).

ESG can be particularly relevant in the biotech space, where companies often operate in areas that overlap with social and ethical responsibility (e.g. health or medical access). Investors who value ESG principles might want to look for ETFs that invest in companies with high ESG scores.

ETF dividends

Some biotech ETFs pay dividends, but payouts tend to be modest compared to other sectors (like utilities or consumer staples, for example). That’s because many biotech companies reinvest their earnings into research and development instead of distributing profits to shareholders.

Those that do pay dividends will often pay them out on a quarterly basis, with the amount depending on the dividend income earned from the underlying holdings. Note that dividends may be subject to federal, state, and local taxes, depending on your jurisdiction.

Biotech ETFs that pay dividends include:

• iShares Biotechnology ETF (IBB): 0.38% dividend yield
• SPDR S&P Biotech ETF (XBI): 0.17% dividend yield
• Invesco Nasdaq Biotechnology ETF (IBBQ): 0.74% dividend yield.

This content is provided for informational purposes only and does not represent a recommendation to buy or sell any product offered by FOREX.com and/or its affiliates. Not all products discussed are available to trade with FOREX.com.