How do you select a biotech ETF? Many people think that ETFs within a particular industry or sector are all the same, and that there isn’t much difference between them. As a consequence, they don’t spend much time learning the difference and this can be a real mistake. ETFs come in all shapes and sizes, and to demonstrate, here is a look at some of the biotech ETFs.
Look at the range in 6-month performance of biotech etfs:
The range in performance is stark. The top-rated biotech ETF has gained 41% in the past 6 months while the bottom performer has lost 2.74%. Granted, the top performer uses triple leverage which dramatically increases risk.
So, what should you look at when you select an ETF? Here are four steps to follow:
1.) First, how concentrated is the ETF? Is the ETF heavily in a few stocks? That may be positive if you like the top stocks or it may be a negative if you want broad diversification in your portfolio. If an ETF is market cap weighted, they will be investing more dollars in the largest stocks in their portfolio, if they are equal weighted, they spread the investment dollars over each stock in their portfolio. Look at the biotech ETF below:
You can see that the top 3 stocks make up more than 30% of the portfolio. If you like Amgen, Celgene and Gilead, then that is a good thing. If you are looking for a broader view, then you may want to look for an equally weighted biotech ETF.
2.) Next, you should know what it is going to cost you on a yearly basis to own this ETF. Not all ETFs are created equally in this regard. In fact, in this list of biotech ETFs the cost basis ranges from 0.34% per year to 0.94% per year. Some ETFs provide more oversight and intervention which will definitely increase your costs, but you will have to determine if that activity is worth it for you.
3.) You will also want to see the size of the ETF and the daily volume. Why are these factors important? You want to make sure that it is not going to be abandoned if it is too small, and that you have the liquidity to trade into the ETF or out of the ETF without impacting the market. The above ETFs range in size from $23 million to $8 billion.
4.) Finally, you will want to understand the philosophy of the ETF. Does it have passive vs. active management? Does it use leverage? This can both make it more risky and potentially open up the ETF to more gains.
Once you have this information, you are in a better position to select an ETF that meets your investment needs. As you can see by looking at this one narrow industry, the investor has plenty of choice, but that choice requires the investor to become educated.