Biotech ETF Industry Outlook For Second Half 2017

Biotech stocks have had a strong run so far in 2017 with the NASDAQ Biotechnology Index soaring 19.4% year-to-date (YTD). This is in sharp contrast to last year’s performance when the Index was down 19.1%. There were several reasons for the sector’s dismal performance last year foremost being the drug pricing controversy.

Apart from drug pricing, there were several other factors that impacted the sector -- 2016 was disappointing from an R&D perspective with a fewer number of drugs managing to gain FDA approval. There were some high-profile pipeline failures as well. Other factors that weighed on the sector include mixed results, slower-than-expected new product launches and increasing competition. (Read: Forget Big Tech; Biotech ETFs are Soaring Higher)

Recovery on the Cards

With the biotech sector performing well this year, it looks like the sector is set for a recovery. New product sales ramp up, R&D success and innovation, strong results, a higher number of FDA approvals and continued strong performance from legacy products are some of the factors that could contribute to a sustained recovery in the sector. Tax reforms and cash repatriation would support a recovery as well.

Importantly, investors now seem to be more comfortable with the drug pricing scenario and are willing to look at the fundamentals of the sector. Expectations are that steps taken by the Trump administration to drive down drug prices will not be as draconian as previously expected. (Read: 5 Reasons Why Biotech ETFs are Surging)

Deregulation and increased competition seem to be some of the ways that will be used to control drug prices. The FDA is working on a plan to lower healthcare costs by speeding up the development of next-generation treatments, especially for rare diseases or targeted cancer therapies.

Biosimilars Pose a Threat

Although biosimilars are yet to pick pace, they remain a major threat for biotech stocks specially companies that are set to lose patent protection for major blockbuster drugs in the next few years. While a relatively new area, the market for biosimilars is huge and highly lucrative with several blockbuster biologics including Humira and Lantus slated to lose patent protection by 2020. Biosimilars are expected to reduce healthcare costs and provide a large number of patients with access to much needed biologic treatments. Biosimilars are also gaining acceptance across formularies.

M&As to Pick Pace in 2H17?

Expectations are high that the biotech sector will witness an increase in M&As as the year progresses -- potential tax reform and cash repatriation are expected to lead to a boost in this area. However, not many deals have been announced this year -- a key reason could be a “wait and watch” approach regarding the drug pricing situation as well as tax reforms. Another deterrent could be high valuations with companies remaining wary of bidding wars leading to over-priced deals.

That being said, companies with innovative technologies and pipelines are highly sought after. Niche disease areas like nonalcoholic steatohepatitis (NASH), immuno-oncology and multiple sclerosis are in demand. Treatments for orphan diseases are also much sought after with quite a few deals being signed in these areas. Biotech companies like Incyte and Exelixis are often considered attractive takeover targets.

Faster Drug Approval Process

The FDA is working on streamlining the development process for drugs for rare diseases as well as for targeted cancer therapies. The agency is also working on clearing up a backlog of orphan drug applications.

So far in 2017, the FDA has given its nod to 23 new drugs, already surpassing last year’s total tally of 22. Among this year’s approvals, drugs like Kevzara (adult rheumatoid arthritis) and Dupixent (eczema) have blockbuster potential.

According to an IMSQuintiles report, the late-phase R&D pipeline for the industry indicates that there should be about 40-45 new brand launches every year through 2021.

Innovative Pipelines & Catalysts

Biotech companies continue to work on bringing innovative new treatments to market, and there could be significant catalysts in the coming quarters in the form of important new product approvals as well as major data read-outs especially in key therapeutic areas like immuno-oncology, Alzheimer’s, hepatitis C virus (HCV), central nervous system disorders, and immunology/inflammation.

Cancer especially immuno-oncology remains a key area of interest. According to IMSQuintiles, 68 new cancer drugs were approved for 22 indications from 2011 to 2016 while worldwide costs for cancer therapeutics and supportive care drugs shot up from $91 billion in 2012 to $113 billion in 2016. More than 600 molecules are in late stage development with the majority being targeted therapy.

ETFs in Focus

Highlighted below are some biotech ETFs -- ETFs present a low-cost and convenient way to get a diversified exposure to the sector.

iShares Nasdaq Biotechnology (IBB)

IBB, launched in Feb 2001 by BlackRock Investments LLC, tracks the Nasdaq Biotechnology Index. The fund mainly covers biotech stocks (82.5%) with pharma accounting for 10.1%, life sciences tools & services for 6.9%, Health care technology for 0.08%, Health care equipment for 0.26% and Health care supplies for 0.04%. The top 3 holdings include Celgene Corporation (NASDAQ:CELG) (8.46%), Amgen Inc (NASDAQ:AMGN). (8.09%) and Biogen (NASDAQ:BIIB) Inc. (8.05%). The total assets of the fund as of Jul 13, 2017 were $9.69 billion representing 162 holdings. The fund’s expense ratio is 0.47% while dividend yield is 0.21%. The trading volume is roughly 2,033,019 shares per day.

SPDR S&P Biotech (MX:XBI) ETF (XBI)

XBI, launched in Jan 2006 by State Street Global Advisors, tracks the S&P Biotechnology Select Industry Index. The fund covers health care stocks only. The top 3 holdings include Vertex Pharmaceuticals (NASDAQ:VRTX), Inc. (3.03%), Ionis Pharmaceuticals, Inc. (2.75%), and Exact Sciences Corp. (2.72%). The total assets of the fund as of Jul 13, 2017 were $3.76 billion representing 92 holdings. The fund’s expense ratio is 0.35% while dividend yield is 0.23%. The trading volume is roughly 8,983,119 shares per day.

First Trust NYSE Arca Biotech ETF (FBT)

FBT, launched in Jun 2006 by First Trust Advisors, tracks the NYSE Arca Biotechnology Index. The top 3 holdings include Alnylam Pharmaceuticals, Inc. (4.78%), Myriad Genetics, Inc. (4.26%), and Regeneron Pharmaceuticals, Inc. (4.03%). The total assets of the fund as of Jul 12, 2017 were $1 billion representing 30 holdings. The fund’s expense ratio is 0.56% while dividend yield is nil. The trading volume is roughly 55,387 shares per day.

VanEck Vectors Biotech ETF (BBH)

BBH, launched in Dec 2011 by Van Eck, tracks the Market Vectors US Listed Biotech 25 Index. The fund covers health care stocks. The top 3 holdings include Amgen Inc. (12.02%), Celgene Corporation (11.09%) and Gilead Sciences Inc (NASDAQ:GILD). (10.12%). The total assets of the fund as of Jul 13, 2017 were $676.2 million representing 25 holdings. The fund’s expense ratio is 0.35% while dividend yield is 0.21%. The trading volume is roughly 31,428 shares per day.

PowerShares Dynamic Biotech & Genome ETF (PBE)

PBE, launched in Jun 2005 by Invesco PowerShares, tracks the Dynamic Biotech & Genome Intellidex Index. The top 3 holdings include Alexion Pharmaceuticals Inc (NASDAQ:ALXN). (5.72%), Celgene Corp. (5.16%), and Ionis Pharmaceuticals, Inc. (5.06%). The total assets of the fund as of Jul 13, 2017 were $244.8 million representing 31 holdings. The fund’s expense ratio is 0.50% while dividend yield is 0.91%. The trading volume is roughly 15,840 shares per day.

Conclusion

Although the drug pricing issue will remain in the headlines until the administration comes out with a policy for controlling drug prices, investors seem to be more comfortable with the issue and are focusing on the fundamentals of the sector. Pipeline success in innovative and important therapeutic areas, cost-cutting, share buybacks, new products, increased pipeline visibility and appropriate utilization of cash are some of the factors that will help restore investor confidence in biotech stocks.

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