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This Biotech ETF Has Thus Far Delivered On Its Potential

Summary The ALPS Medical Breakthroughs ETF – a fund focused on companies in late stage clinical trials – has jumped over 20% YTD, far outperforming small cap & biotech counterparts. This ETF looks for companies with at least one drug in stage II or stage III clinical trial. The fund’s managers have demonstrated a solid albeit short track record over the ETF’s nine month history outperforming small cap, biotech and pharma indices. This ETF was hit especially hard during this week’s rout in biotech. At the beginning of the year, I profiled the ALPS Medical Breakthroughs ETF (NYSEARCA: SBIO ). It’s a fund that is trying to carve out a unique niche in the biotechnology space by investing in those companies engaged in late stage clinical trials. By their very nature, these companies and the ETF itself are a high risk, high reward proposition but in its brief nine month history the fund has been able to deliver on its potential. First off, let’s review the investment criteria of the fund… To qualify for this ETF the company must have at least one drug in either stage II or stage III clinical trial. Often times these companies are very small (currently about 70% of fund assets are devoted to either small cap or micro cap businesses) and generate little if any revenue. Their upside is captured in either the success of the drug in trial or the possibility of being acquired by a larger company. Since its inception at the beginning of the year the fund has delivered against just about any benchmark you can think of. While the fund has whipsawed around and experienced the high degree of volatility that one would expect from a small cap biotech ETF the fund has managed to deliver outsized returns in its short existence. Consider its performance against the biotech indices… SBIO Total Return Price data by YCharts Biotechs in general have performed well this year beating the iShares Nasdaq Biotechnology ETF (NASDAQ: IBB ) by a large margin and more than doubling up on the SPDR Biotech ETF (NYSEARCA: XBI ). The ALPS ETF does have a roughly 50-50 weighting of both biotechs and pharmaceutical companies but this chart demonstrates how this ETF is handily beating both the SPDR S&P Pharmaceuticals ETF (NYSEARCA: XPH ) and the iShares U.S. Pharmaceuticals ETF (NYSEARCA: IHE ) for the pharma sector as well. SBIO Total Return Price data by YCharts Measuring against the small cap ETFs (the iShares Core S&P Small-Cap ETF (NYSEARCA: IJR ) and the Vanguard Small Cap ETF (NYSEARCA: VB )) yields similar results. SBIO Total Return Price data by YCharts Perhaps a fairer comparison comes when you look at this ETF against the ETF that debuted just a couple of weeks earlier – the BioShares Biotechnology Clinical Trials ETF (NASDAQ: BBC ). SBIO Total Return Price data by YCharts I say a fairer comparison instead of a good comparison because while the two ETFs share a similar strategy of going after clinical trial companies the stocks they target are quite different. For example, the ALPS ETF typically invests in nothing with a market cap greater than $5B. In comparison, the BioShares ETF has over half of its assets in companies with market caps greater than $10B. Perhaps it’s not surprising that the BioShares ETF has performed much more in line with its counterparts. It’s not all smooth sailing though with biotechs though. Biotechs in general lost roughly 10% of their value this past week alone giving shareholders a first hand look at the risks involved in these emerging companies. Putting further pressure on biotechs was the news that Hillary Clinton is looking to rein in prescription drug costs and place a monthly cap on some premiums. This is campaign season and everything we hear from politicians at this point should probably be taken with a whole shaker of salt but potential revenue limits could be a consideration going forward. Conclusion Nine months is a very short time to be judging performance but it’s encouraging to see how well the fund managers have been able to outperform in such a challenging environment. The short track record has done wonders in attracting investment to the fund as it already has $160M in AUM – far more than the roughly $28M managed by the BioShares ETF. An overall expense ratio of just 0.50% also helps its cause. The focus on companies engaged in later stage clinical trials offers greater intrigue. By stage II or III, the drug has cleared its initial hurdles and stands a much better chance of making it to market and that helps remove a level of risk and uncertainty. However, we have many examples of what happens to a company’s stock if its drug fails in trial. While the home run potential is there with many of these companies there’s also a huge downside risk if the drug fails to get approved. So far, the initial results are encouraging as the managers have had an albeit small degree of success in picking the right stocks. I like the promise of this ETF, although I’m also waiting to see how the managers perform over a longer time frame.

Public Utility Commission Decisions Will Determine The Future Of Investor Owned Utilities

Investors in utilities should be considering the impact of alternate energy sources on utilities. One of the best way to measure the impact is by looking at the decisions of the Public Utility Commissions and how they respond to alternate energy sources. We look at California market as one example where the Public Utility Commission decisions should discourage utility investments. When electricity rates go up in a region, consumers in that region are quick to blame the local utilities and cast them as villains. This phenomenon is particularly acute when it comes to Investor Owned Utilities. While the IOUs profit motive gets most of the blame, in many regions of the US, utilities operate under some very specific mandates from local Public Utility Commissions. This dynamic did not matter much to utility investors in the past since utilities were in a monopolistic situation and customers did not have much of a choice when it comes to energy sources. However, times are changing and in this era of distributed energy, utility investors should factor in the mindset of the relevant PUCs in determining which utility investments are vulnerable. The concern about utility future is especially acute in states where solar penetration is increasing rapidly. In these states, a local PUC’s response to solar and wind technologies is one very good way to assess whether a utility can do well in its regulatory landscape. In this context, we look at the regulatory landscape in California – a state with the highest solar penetration in the US outside of Hawaii. California Public Utilities Commission, or CPUC, after much contentious dialogue, announced a much awaited new rate design a few weeks back. While not completely unexpected, the rate decision is reflective of ongoing poor rate setting history in California and has severe long term implications for California’s three major Investor Owned Utilities Pacific Gas & Electric (NYSE: PCG ), Southern California Edison [owned by Edison International] (NYSE: EIX ) , San Diego Gas & Electric [owned by Sempra Energy] (NYSE: SRE ) While the decision itself is a long complex document with many nuances, the highlights of the ruling are as follows: – A minimum bill of $10 as opposed to a fixed bill requested by the utilities – Two tiered rate structure with a 25% cost difference between the tiers – A new super user rate for heavy electric users – A relatively accelerated path to TOU rate structures – 4 year glide path to new tiered rate structures Almost all of these decisions, except for the TOU rate structures, while directionally positive compared to the prior rate structures, fall woefully short of what is required to align California electric rates with the market forces. In evaluating the decision, it is instructive to understand the parameters that the PUC set for itself for this rate design. The so-called rate design principles, RDP, adopted by the Commission are as follows: 1. Low-income and medical baseline customers should have access to enough electricity to ensure basic needs (such as health and comfort) are met at an affordable cost; 2. Rates should be based on marginal cost; 3. Rates should be based on cost-causation principles; 4. Rates should encourage conservation and energy efficiency; 5. Rates should encourage reduction of both coincident and non-coincident peak demand; 6. Rates should be stable and understandable and provide customer choice; 7. Rates should generally avoid cross-subsidies, unless the cross-subsidies appropriately support explicit state policy goals; 8. Incentives should be explicit and transparent; 9. Rates should encourage economically efficient decision-making; 10. Transitions to new rate structures should emphasize customer education and outreach that enhances customer understanding and acceptance of new rates, and minimizes and appropriately considers the bill impacts associated with such transitions. What is most ironic about these rate design principles is that many of these goals are in conflict with each other and there is not a single criteria that mentions the goal as delivering low cost long term electricity to consumers. Understandably, a look at the pricing difference between California IOUs and municipal utilities (image below from energy.ca.gov) indicates that CPUC has largely been a failure in delivering low prices to California consumers. (click to enlarge) The root of the problem related to CPUC’s incoherent principles and an over reliance on cost based metrics, instead of market based metrics, in setting utility directives. This poor process has led to historical over investment in assets to justify a higher return to the IOU shareholders. This worked reasonably well for all involved (except customers) as long as there was no competition to the utilities. However, solar energy, and to a lesser degree, wind energy, are dramatically changing the market place dynamics. With many alternate sources of distributed generation accessible to customers, utilities are no longer the energy generating monopolies they used to be. The CPUC, unfortunately, continues to see consumers as subjects that pay the rates they set without considering that the electric generation landscape has changed and the consumer today has choices. CPUC rate structures hide many different subsidies in the form of volumetric rate structures. These subsidies will be problematic to utilities because they are not applied evenly across all the energy sources and will be increasingly coming at the expense of utilities. By being oblivious or nearly completely ignoring market forces, the CPUC is on the course to making utilities a lot less relevant for a big part of its customer base. Given the exponential growth in solar, this subsidy structure will start exacting an increasingly heavier toll on these utilities. The problem, especially in California, is likely to get worse if the PUC continues with its net metering policies and layers in subsidies for battery technologies on top of the already expensive other subsidies. Unless Pacific Gas & Electric, Southern California Edison, and San Diego Gas & Electric can meaningfully alter this regulatory landscape, their future in California will be threatened. Investors will do well to stay away from these and other utilities that operate in an archaic framework that does not properly recognize the threat of solar to the utility business models. We see Pacific Gas & Electric as one of the highest risk utilities. Our view on PCG: Avoid

The Cash Is King Playbook

We’re seeing something really unusual in the financial markets this year. As I’ve noted recently , there’s almost nothing that’s working this year. No matter where you’ve diversified your savings you’ve likely lost money with the exception of cash. If we look at the two primary asset classes, stocks and bonds, cash has only outperformed both in the same year 10 times in the last 90 years. So this is a pretty unusual event. But there’s some potential good news on the horizon. When this occurs both stocks and bonds tend to bounce back very strong. In the 10 times this has occurred in the last 90 years stocks have followed up with average 1, 2, and 3 year returns of 14.34%, 18.76% and 16.72%. Bonds have done a bit worse with a 1, 2 and 3 year average return of 10.24%, 7.7% and 6.17%. A balanced portfolio has also generated abnormally high returns with a 1, 2 and 3 year average return of 12.29%, 13.23% and 11.44%. As is often the case with diversification, it’s not timing the market that counts. It’s time in the market. So, while cash looks particularly smart today the historical figures say that cash won’t be king for long. Share this article with a colleague