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“Beating the market” is fun. Beating the market while taking less risk is even more fun. Biotech investors have had a lot of fun in recent years. Just over two years ago I examined the performance of 3 popular biotechnology ETFs and concluded they provided “outstanding risk adjusted returns.” In finance our traditional measure of risk is beta , a measure of how sensitive a portfolio’s return is to the returns of the overall market. The latter is obtained by looking at the S&P 500 or its eponymous ETF, the SPDR S&P 500 Trust ETF ( SPY). There are several biotech ETFs, but I chose the iShares Nasdaq Biotechnology ETF (NASDAQ: IBB ) back then for several reasons: It is by far the largest fund, by portfolio dollar value; It is the most diversified, having a the large number of holdings; and It is the very liquid, trading millions of shares daily and weekly. Source: etfdb.com In addition, IBB has traded the longest and has ten years of data on the portfolio risk profile. Surprisingly, while most investors think of biotech as very risky and volatile, this long term measure of the IBB’s beta shows it to be .67, significantly less than that of the overall market. ( Source: yahoo finance ). Remember one of your first lessons in finance: a portfolio may be quite volatile, but if its zigs and zags are not correlated with the broad market swings, the portfolio is not as risky as it first looks! IBB is a classic example of this. Furthermore, unlike the betas of individual stocks, the betas of portfolios are far more stable over time. Long term risk adjusted comparisons are therefore valuable and reasonable. I will continue to focus on IBB in this article as a result. What does this mean for long term biotech investors? As is clear from the chart below, IBB has walloped the market’s overall return in recent quarters. (click to enlarge) Source: bigcharts.com How great is this performance? Since April 15th of 2014, when the last big correction in stock prices ended, the broad market has gained about 7% in value. Since IBB has a beta of .67, we would expect this portfolio to gain: (beta) x (S&P 500) = expected return, so (.67) x (7%) = 4.2% What was the actual return over this period? Close to 40%, even after the sharp selloff in Biotech shares in the most recent correction! By the way, I could easily have shown a very short term graph of IBB since this past August and it would show that IBB has fallen much more than you would expect. But remember, as SA readers we should be long term investors–not short term traders. Especially in a sector such as biotech, where it takes patience while new medical innovations break out of the laboratory. In addition, over very short periods of time—such as the last 2 months—any portfolio may see a surge in risk. That is precisely why I used the ten year data: to filter out such noise. A technician would say IBB is “oversold.” A fundamental analyst would continue his due diligence and see if the recent shakeout was due to some change in this industry’s long term prospects. Five of IBB’s top ten holdings have seen downward earnings revisions in recent weeks; on the other hand, three–including giants like Amgen (NASDAQ: AMGN ) and Gilead (NASDAQ: GILD ) have seen substantial upward revisions. In summary, while recent wobbles have given biotech fans some scares, the industry retains most of its low risk profile and long term potential. In financial statistical analysis, high returns at low risk are the alpha that investors crave, and for which this site is named. Keep biotech on your radar for a long time to come. Scalper1 News
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