We are all aware of how bad $xbi (biotech ETF) has been over the past year.
$XBI is flat over the past three years, down -30% over the past year, down -20% YTD in 2022.
This is particularly painful as $XBI is often utilized as an investment vehicle that generalist investors (i.e. non-biotech specialists) use to gain biotech exposure without doing individual stock picking or taking clinical trial risks. Big sell-off of $XBI has been caused by overall risk-off sentiment – which led to generalists, who drive significant amount of capital flow in a single sector, to offload their exposure of biotech.
With no generalist support or biotech specialists who have already been hurt from sell-off in 4Q21, all biotech stocks and $XBI have helplessly traded down with no support.
However, as investors, we always need to be forward-looking – what has happened has happened – so what now? Is biotech sell-off done? If so, is $XBI a good investment vehicle to ride the upswing in biotech stocks?
No one can tell if biotech sell-off is done, but we can have a view on whether $XBI is a good investment vehicle to ride the wave up if one is bullish on $XBI
Based on what I see in $XBI’s portfolio holdings, MY ANSWER IS NO – $XBI is no longer a great investment vehicle.
For me, main problem with $XBI is that it is equal composition – so every stock is equal-weighted without regard to 1) liquidity of the stock and 2) market capitalization.
Therefore, $VRTX, a biotech darling with $69BN market cap, ended up having similar weighting as $ALKS – a specialty pharma with no great history of capital allocation with $4bn market cap.
Because of the equal exposure, the $XBI has HEAVY EXPOSURE OF small / mid capitalization biotechs that have not been able to tab the equity capital market for a while – waiting for that bounce.
WHAT THIS MEANS IS THAT A SIGNIFICANT PORTION OF BIOTECH COMPANIES WILL RAISE MORE MONEY AT THE FIRST SIGN OF A RECOVERY – PUTTING AN ENORMOUS FINANCING RISK AND THEREFORE CEILING FOR THE INDEX.
Given they are equal-weighted, the index itself also does not need increase weighting / buy more shares should the market capitalization of its components increase – because there is no % weighting that the index needs to truly replicate.
Therefore, looks like $XBI is weighted towards more downside than upside with fairly low ceiling for the upside while downside could be greater given that there is no liquidity and support.
SO HOW SHOULD ONE MAINTAIN EXPOSURE TO BIOTECH?
It is time for classic stock-picking with no beta exposure – it is the market for multi-manager hedge funds like Citadel / Millennium / Balyasny – where you take idiosyncratic (stock specific) bets on while hedging out other factors as much as you can.
I discussed why pension funds are allocating more capital to this strategy – and they were right!
For the time being, taking directional bet on biotech through index seems to present poor risk/reward profile.
The stock picking time in biotech is here and we all should take advantage of it.
You are addressing generalists yet suggesting a specialist solution. Simply suggesting peeps run a L/S strat is not only unhelpful but dangerous for most. Equal vs. market cap weighted both have pros/cons. Perhaps offering an assessment of generalist substitutes of XBI would offer much more value to your readers.
Thanks for feedback! for generalists, I think single stock picking or buying what you know well is the optimal way to gain exposure to biotech rather than buying a basket. Perhaps IBB or owning large cap pharma is a better way to gain exposure to innovation than XBI. Thanks again!