IBB - IBB: Biotechnology Securities Might Be Getting More Attractive As Recession Fears Loom

2023-03-28 07:31:34 ET

Summary

• IBB invests in biotechnology stocks predominantly in the United States.
• The healthcare sector is renowned for its relative stability during market fluctuations compared to that of more procyclical alternatives in sectors like financials and technology.
• Opportunities to profit from biotechnology growth as well as resilience to market volatility could make IBB potentially attractive amid the current macroeconomic circumstances and forecasts.

The healthcare sector has historically been home to many safe-haven assets that have allowed this sector to experience fewer losses during periods of economic decline. For this reason, I rate the iShares Biotechnology ETF ( IBB ) a buy.

The healthcare sector is known to be especially stable as the demand for their products and services is relatively independent of economic conditions. These products and services may include drugs, vaccines, and other medical treatments. Furthermore, many need these to live comfortably and directly improve their quality of life. For this reason, many individuals might be more willing to pay for these even if they increase in price. IBB holds companies whose services are more directly integrated with human life than companies within any sector I have covered thus far, making it especially interesting to research. These same companies often have their own implications that could influence price performance, which I address later in this article.

The profits of healthcare companies tend to be less volatile in response to macroeconomic events and price fluctuations. In addition to this reduced volatility, the biotechnology sector also has decent room for growth, especially with the emergence of new artificial intelligence systems.

In the event of persistent hikes or a market crash , healthcare securities could prevail and possibly increase in popularity. For its general stability and capability to persist through rough market conditions, IBB could serve investors well in the medium-long term.

Strategy

This ETF tracks the ICE Biotechnology TR USD Index and uses a representative sampling technique. IBB invests in both growth and value stocks across a range of market capitalizations. This ETF’s representative sampling approach could also serve to provide investors with only the highest quality companies within the relevant index.

Holdings Analysis

IBB invests solely in healthcare stocks that are primarily centered on biotechnology. These companies are generally associated with biotechnology research and development (R&D), biopharmaceuticals, and healthcare products. This ETF’s holdings reside mainly in the United States, with a mere 10% of holdings appearing outside the country. Non-United States holdings in this ETF are located primarily in Europe and East Asia. Though geographical diversification is apparent, I would not consider it a fundamental component of this fund.

The top 10 holdings in this ETF account for 53% while the top 25 comprise 75% of total holdings. Therefore, it’s safe to say that IBB is quite top heavy and may pose concentration risk. Though healthcare stocks have shown to be resilient amid bear markets, investors may still want to consider concentration risks and how specific events could move the needle in this fund.

Strengths

The biotechnology industry has strong growth forecasts that could potentially translate to elevated returns for investors. At a CAGR of 14%, the United States biotechnology market could exceed $3.8T by 2030, as seen in the picture below.

Investors could flock to healthcare stocks as safe-haven securities amid macroeconomic scares. As recession fears continue to loom heavily, IBB may have a silver lining in the current market.

In previous articles, I have used an ETF’s reaction to the 2022 bear market to roughly forecast the fund’s future ability to hedge inflation as more hikes could be on the way.

The chart below compares the performance of the biotechnology industry against technology, financials, cybersecurity, and the broader market. The gap between biotechnology and other sectors appears to begin in July 2022. Furthermore, the gap appears to widen significantly in October of the same year, and continued widening in the months following. The market first started to rally in July , and rate hikes became particularly unrelenting in October and November.

Based on the chart, IBB has consistently outperformed alternatives in other sectors since the onset of the 2022 bear market. Though past performance is not fully indicative of future potential, this ETF may have some fundamental edges in the current environment compared to its more procyclical counterparts.

Weaknesses

Biotechnology securities are generally more robust to market downturn, however, they can still be quite volatile. For example, IBB’s annualized volatility and max drawdown are both roughly 17% greater than that of the broader market.

The healthcare sector is prone to specific price catalysts that are somewhat separated from other sectors. Potential catalysts might include clinical trial results and other disclosures from the Food and Drug Administration ((FDA)). Both of these factors alike could generate significant ripples across the healthcare sector that could affect the price of assets like IBB.

Healthcare products and services are also often strictly regulated and under heavy scrutiny because of various safety and ethical concerns. Therefore, many biotech companies may have trouble initiating operations that would move their stock price because they first have to cross several legal barriers. This might make growth slower despite being more resilient.

Opportunities

The biotechnology industry could benefit from growth in the artificial intelligence industry . As ((AI)) becomes more advanced, it could potentially be used in drug discovery as well as creating more personalized treatments.

As the Fed remains narrowly focused on inflation , rates could be kept high in the coming periods, even if the market is looking for pauses or cuts. This is likely to endanger growth within sectors like financials and technology. Alternatively, this could give healthcare funds like IBB a chance to outperform and shine light on its inflation-hedging potential.

Threats

IBB may not be directly vulnerable to economic downturns, but certain companies held in this ETF might still struggle during periods of capital shortage and high interest rates. The recent collapse of several banks could even have some indirect implications for the biotechnology industry. In specific, Silicon Valley Bank ( SVB ) that was at the center of the bank runs, was a lending partner to emerging drug companies. Since these crises, some have speculated that biotechnology startups could have a significantly harder time obtaining funding in the future. This could ultimately reduce both the number of emerging biotechnology companies and the industry’s overall profits.

Biotechnology companies like those held in IBB also generally have higher research and development (R&D) costs compared to non-healthcare companies. R&D expenses are typically quite heavy, and are getting more expensive with time. R&D becoming too expensive could ultimately reduce the profitability of this ETF.

Conclusions

ETF Quality Opinion

As someone whose interests transitioned from medicine to finance roughly a year ago, I found this ETF especially interesting to cover.

IBB possesses a quality portfolio of biotechnology stocks that could well grow in the long term while possibly hedging economic downturns along the way. I am interested to see whether more investors resort to healthcare securities in the short-medium term as the Fed remains hawkish. For these reasons, I plan to follow this ETF in the long term.

ETF Investment Opinion

I rate IBB a buy. This ETF is slightly undervalued compared to the broader market and investors could reap significant benefits in the next several years by owning this ETF. This ETF has outperformed the broader market for several months now and could continue in the event of prolonged inflation or a recession. Therefore, I believe IBB could be in for a smoother year compared to many others I have covered previously.

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