2023-05-27 05:44:08 ET
Summary
- There are several choices for investors interested in biotech exposure through an ETF.
- Data analysis shows that biotech ETF returns are more sensitive to timing than the S&P500 and have higher probabilities for negative returns.
- VanEck's Biotech ETF comes with strengths and weaknesses, but is an overall solid choice for a biotech-focused fund.
Overview
The VanEck Biotech ETF ( BBH ) is one of several choices available to gain focused exposure to the biotechnology industry. It's been around since 2011 and has almost $500 million in assets. The fund seeks to replicate the MVIS US Listed Biotech 25 Index which focuses on companies involved in the development and production, marketing, and sales of drugs based on genetic analysis and diagnostic equipment. The index uses market capitalization for both the selection and weighting of constituents and does include some global exposure, although it remains overwhelmingly focused on US companies like the rest of the biotech ETF space.
The expense ratio of 0.35% ranks among the lowest in the space. The low number of holdings combined with a market cap weighting scheme lends to a higher concentration of top 10 holdings at 64%.
Amgen ( AMGN ) fills in at the top spot, accounting for over 11% of the fund.
BBH ETF Analytics
Annual returns can be highly dependent on when an investment was made. For the most part, total return performance from financial sources is anchored to the end of the reporting period and only applies to investors who bought around the start period. That's just one point of reference. If it just so happens that 10 years ago marked the bottom of a market decline, the returns are going to be inflated for those 10 years and not necessarily indicative of what a typical 1-year return would be. I attempt to provide a better representation of annual returns by taking many more data points over 10 years.
Over 10 years, there are 2,226 distinct 1-year periods and each one is considered an equal probability outcome. The following graph shows the total return for all 1-year periods in the last 10 years for BBH.
As is evident in the graph, returns for any given year are highly dependent on when the purchase was made. A tabulated view of the above data shows the general distribution of outcomes for returns. The probability of hitting a positive return favors the investor at 2-1 odds over negative outcomes, and the chance of beating the average return is roughly equal to performing worse than average.
The average return for all 1-year periods is 9.24% and the standard deviation of those returns is 19.90%. From here, we can calculate a measure of risk using a return per unit of risk metric. The following table shows return/risk data for 1-year and daily return periods.
Another important consideration is tail risk. The following table analyzes tail-risk, showing the historical chance of exceeding a 3-sigma move in either direction. Observations for 1 and 2-sigma moves are also shown and give a general idea of the probability of outsized gains or losses.
The following table shows the percentile distribution for 1-year returns. It also shows a cumulative return, which I like to use as a measure of how important timing is with a particular ETF. I look to see which percentile the cumulative average turns positive, which is the 74th percentile in the case of BBH. The higher the percentile, the more timing plays a role in future annual returns.
The table shows that the median return, 50th percentile, is 8.59%. It also shows that the 34th percentile marks the positive return point, which aligns with the positive return outcome probability of 66.20% given earlier. Playing around with some numbers shows that a 1-sigma return to the upside calculates out to be 29.14% and marks the 82nd percentile.
Another view of the percentile distributions of returns is presented in the following graph.
Next up, I look at determining the relationship between expected returns based on the prior 1-year return. The following graph shows 1-year returns in blue along with corresponding prior-year returns in red, sorted by prior-year performance.
The trend lines indicate an inverse relationship between expected returns and those of the prior year. Lower prior-year returns generate higher returns the following year and vice versa, confirming mean reversion properties. For example, buying BBH at the end of the highest 1-year return periods has produced net negative returns the following year. Using the trendline formulas provided in the graph along with the latest 1-year return for BBH, we can predict expected future returns. The latest 1-year return for BBH is 10.25%, which we can plug into the prior year trendline formula,
.1025 = 0.00032x - 0.20267, which solving for x yields 953.65.
We can then plug that into the trendline formula for 1-year returns,
y = -.00010 (953.65) + 0.16158 which yields 0.0662, or 6.62%.
The expected return of 6.62% is less than the average return of 9.24% and implies a suboptimal time to buy BBH. These calculations are intended to provide a baseline for expectations.
ETF Comparison
Now that we've looked at the specifics for BBH, we can see how it stacks up against other biotech ETFs. The stalwart SPDR S&P 500 ETF ( SPY ) is also presented as a general market benchmark for comparative purposes, but will not be part of the discussion.
The following table presents return and standard deviation data along with high-level outcome probabilities.
BBH stands in the middle of the road as far as average 1-year return performance over the last 10 years, but also comes with the lowest standard deviation. The return/risk of 0.0296 compares well to the group in general, but the lower 1-year return hampers it from reaching the top spot for risk-adjusted return. The First Trust NYSE Arca Biotechnology Index Fund ETF ( FBT ) takes the top spot for risk-adjusted return at 0.0321. The breakout of positive and negative outcomes is pretty consistent across all ETFs, but BBH fails to hit the 2-1 margin ever so slightly.
The next table sheds more light on average returns and also provides some insight into how much timing affects performance. The cumulative average percentile column gives the 1-year average return percentile, where the rolling cumulative average achieves a positive return. The higher the number, the more timing affects performance. Skew is the ratio of better than average and worse than average, and shows whether returns skew to the upside or downside.
BBH shows a slightly negative skew for returns being worse than average, but also has the lowest average for negative returns. Timing is an important factor for all of the funds.
The next table compares outsized moves for each fund. Probabilities for 1, 2, and 3-sigma moves to the upside and downside are given. These are then blended to provide an overall probability for an outsized move, greater than 1-sigma, based on a normal distribution.
The final result shows that BBH has the best-outsized return combination, with a big gain/loss ratio over 1.
Takeaway
This article covered a handful of biotech-focused ETFs to compare to BBH and showed that it can be a solid choice to fill that space in a diversified portfolio. The low expense ratio is attractive, and the high top 10 concentration hasn't appeared to affect the fund negatively from a risk standpoint. It does a good job of keeping the average loss in negative return periods limited. It's a fine hold at the moment, with it closing at $158.42, but I'd wait for a lower entry point for a new position to increase the chances for better returns.
For further details see:
BBH: A Solid Choice For Biotech Exposure