Playing To The Strengths Of Biotech

The biotech sector is not the gamble it was in recent years. The industry is quickly becoming a perfect investment storm of improved drug development technology and clinical testing, more efficient FDA approvals, and better funding in venture capital. When looking to minimize risk while maintaining potential for long term gains, it is important to approach the sector with a diversified strategy that focuses on names that are well-established in the business. This goes far in helping investors avoid the "hit and miss" trading volatility that is typically associated with positions taken in biotech stocks.

Avoid the One-Hit Wonders

The usual risks involved when investing in the biotech industry are seen when media hype or success with a single product or patent distracts the attention from the companies that are best established in the business. Companies with long-developed industry networks do not carry the same risks as companies without established connective pipelines to other players in the sector. One example of a company with a wide variety of established pharmaceutical products already available on the market is Celgene (CELG). Celgene's main focus has been Abraxane, a cancer drug to treat metastatic breast cancer.

Abraxane received approval in 2005, but has garnered more attention recently with encouraging test results and new indications. One of the additional indications came last October and shows potential uses for advanced non-small-cell lung cancer. Later in the year, Celgene announce that a combined treatment of Abraxane and Gemzar (which is produced by Eli Lilly) increases the survival rates for pancreatic cancer patients. From a profit standpoint, Celgene's long-term expectations are for revenues to double (and for total profits to triple) in the next five years. In support of these expectations, we are seeing the approval of multiple myeloma drug Pomalyst, and the likely approval of psoriasis drug Apremilast in addition to the variety of new indications for Abraxane. The combination of these factors presents some strong opportunities for investors looking for new exposure in biotech.

Look for Varied Drug Innovations

While it is important to seek out well-established companies with a proven product line, it should be remembered that it is still possible to find long-term opportunities in companies that are still in the clinical stage. In these cases, risk can be reduced by identifying those companies with a diversified set of drug innovations. So, when smaller companies are limited in the types of diseases and treatments, there is generally less protection from investment risk. One example of a smaller company with strong product positioning is ImmunoGen (IMGN).

ImmunoGen's central focus is on targeted antibody payload technology (TAP), which is a chemotherapy treatment for reduced capacity cancer cells. Earlier this year, the HER2-positive breast cancer drug Kadcyla received approval from the FDA. Most encouraging about the progress is the fact that this creates additional possibilities for the combination therapies using the TAP technology. ImmunoGen has reached for late-stage trials for one of its compounds, mid-stage trials for eight of its compounds, and has nine compounds in early-stage trials. This essentially means that ImmunoGen has 18 separate opportunities to use its TAP technology with compounds developed by its pharmaceutical and biotech partnerships. This product diversification presents some interesting (and risk-protected) opportunities for long-term investors.

Diversification in Stock Selection

Investing in biotech can seem intimidating, given the complex nature of the industry. So, for those looking for a simple way to gain exposure to the industry, a basket sector ETF might be the best choice. The clearest option here is the SPDR S&P Biotech ETF (XBI), which has nominal gross expense ratio of 0.35% and an average return of nearly 10% since it was started in 2006. The fund's holdings include Sarepta Therapeutics (SRPT), which has made well-documented progress in Eteplirsen, its Duchenne muscular dystrophy drug. Most analysts expect Eteplirsen to receive relatively quick FDA approval, helping support the underlying value of the stock. Other holdings include NPS Pharmaceuticals (NPSP), which recently bought back the right to Gattex, a short bowel syndrome drug.

Another selection to consider is the Market Vectors Biotech ETF (BBH). The fund has seen returns of a massive 55% since its inception and has a net expense ratio of 0.35%. This fund is centered on fewer stock selections (in contrast to the SPDR S&P Biotech ETF), so there is an enhanced potential for price volatility. Fund holdings include Gilead (GILD), Celgene and Amgen (AMGN), which make up more than 2/3 of the fund. This essentially means investors will sacrifice some of the diversification that can be found in choices like the SPDR S&P Biotech ETF, but many of the individual selections are well-positioned for gains for the remainder of the year.

So, while biotech investments might seem overly complicated and unnecessarily risky, it should be remembered that there are some steps that can be taken to separate the wheat from the chaff and reduce risks in biotech investments. Additionally, there is a variety of vehicles that can be used to gain exposure to the industry. For those less confident, ETFs should be considered as a means for obtaining well-diversified exposure and to capitalize on the long-term prospects in biotech.

About the author:RichardCoxRichard Cox is a university teacher in international trade and finance. Lecture halls of 80 to 120 students. Lessons in macroeconomics and price behavior in equity markets. Investing strategies in these articles are based on technical and fundamental analysis of all the major asset classes (stocks, commodities, currencies). Trade ideas are generally based on time horizons of one to six months. Follow me on Twitter: @Richard_A_Cox

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