In this article, we highlight 3 ETFs poised to benefit from the rush to find a Coronavirus vaccine. We have no clue which specific company will develop the most effective vaccine or be first to market. That’s why we prefer ETFs that have broad exposure to vaccines, therapies, and other biotechnology. We also want to be clear that our investment thesis is more about investor psychology than anything else. The Coronavirus has added a new binary risk to markets for years to come: a global pandemic. We believe the fear of another pandemic happening again, or this current one lasting longer than expected, will drive positive investor sentiment towards the biotechnology sector for years to come.
IBB, the biotech leader
The most well-known biotechnology ETF is the iShares Nasdaq Biotech ETF, IBB. This ETF tracks the investment results of an index composed of biotechnology and pharmaceutical equities listed on the NASDAQ. Here’s what we like about IBB:
- Diversified exposure to the largest biotech and pharmaceutical companies in the world. This includes Gilead (GILD), whose Coronavirus treatment reportedly reduces the risk of death in severely ill patients.
- IBB uses a passive investing method and tracks its index very well. It is not trying to “beat” the index. The index itself is well diversified within the biotech and pharma sector.
- IBB has a long track record, having first started trading in 2001. It has $40 billion in assets under management, making it the most popular biotechnology ETF on the market by far.
Top sectors and holdings in IBB (from ETF.com):
ARKG, the best performer
The best-performing biotechnology ETF is the ARK Genomic Revolution ETF, ARKG. This ETF has a very broad investment mandate, but in general, ARKG invests in companies specializing in genomics. There’s a lot of fancy words on the ARKG website that are better suited for a doctor or scientist than they are for us. But to the laymen, you just need to know that this ETF is investing in more speculative biotech companies than something like IBB. Here’s what we like about ARKG:
- The broad mandate, no underlying index, and active investing method means ARKG can invest in smaller and lesser-known companies. This fund can be used to complement small-cap allocation targets.
- ARKG typically invests in higher-risk biotech stocks with high risk/reward profiles, making it a suitable ETF for aggressive-growth seeking investors.
- An investment in ARKG is an investment in a female-led ETF. Catherine D. Wood, head portfolio manager of ARKG deserves more recognition for her pioneering work in the field of thematic investing. We’re happy to support her.
Top sectors and holdings in ARKG (from ETF.com):
GNOM, a passive version of ARKG
The smallest ETF we’re highlighting is Global X’s Genomics and Biotechnology ETF, GNOM. This ETF is very similar to ARKG in terms of its investment mandate, except with one key difference: GNOM is a passive ETF. This means that the holdings in GNOM can only change once per year when the fund’s semi-annual rebalance occurs. ARKG meanwhile, is an actively-managed ETF, which means the holdings can change daily as the portfolio manager sees fit.
The best way to understand the difference between the two is this: at the beginning of the year GNOM will pick 30-50 stocks that it feels best fits its investment mandate. It will buy those stocks and hold them for the first six months of the year. After six months, GNOM will rebalance its portfolio (and possibly make additions/deletions). ARKG, on the other hand, can buy and sell the stocks inside its portfolio as often or infrequently as it wants to. So ARKG’s holdings on February 1st might look much different than they were on January 1st.
Top sectors and holdings in GNOM (from ETF.com):
Understanding allocation and the thesis
We consider all of these ETFs to be higher-risk. However, among the three, we would say IBB has a lower risk-profile than ARKG or GNOM. So when it comes to allocating to any of these, as we do with any non-market index-based allocation, we keep things pretty small. In general, we might dedicate 1-2% of an equity portfolio to these ETFs. And in doing so, we’d subtract 1-2% away from a growth allocation. For example, if we typically invest 12% of an equity portfolio in a large-cap growth ETF like IWF, we would reduce that to 11% and then put the leftover 1% in IBB (since IBB invests in large-cap biotechs, which we classify as growth). This way we’re keeping our large-cap growth allocation consistent at 12% instead of unintentionally raising it to 13%.
Readers should understand we are not investing in these ETFs because we think a Coronavirus vaccine is going to generate hundreds of billions of profits for the industry. We’re investing in these ETFs because we think there will be a prolonged fear among investors that a virus could grip the economy again. And we think this fear will drive investors to invest in companies that are finding preventive drugs to guard against this risk. Thus, creating a bullish backdrop for the biotech sector.
In addition, there is a second derivative effect of investors now having heightened awareness in general to viruses and diseases, and how they can profit off of that in their investment portfolios. We see this as a long-term investment theme that stays at the top of investor’s minds for at least the next 3-5 years, especially every Winter. Rather than try to pick the specific winners in the industry themselves, we’d rather just bet that the industry wins.
One note of caution
Just as investors like us are looking for opportunistic ways to invest in themes that will benefit from the Coronavirus fallout, Wall Street banks are trying to cash in. In the last two months, there has been a flurry of new niche ETFs to hit the market to capitalize on investor demand for Coronavirus-inspired investment themes just like the one we wrote about in this article. While some of these new ETFs may be well-intended and structured, we think its a classic money grab by the fund providers. We haven’t seen a new ETF launched in the biotech space within the last two months that we would invest in over any of the three we mentioned here.