How to Find the Best Biotech ETFs

Biotechnology might not be at the top of every investor's mind, but biotech ETFs (exchange-traded funds) should always at least be on your radar.

This area of healthcare resides at the intersection of biology and technology. It leverages cellular and biomolecular processes to create new technologies, from healthcare to sustainable fuel sources and agriculture practices. The industry may have garnered more interest thanks to the COVID-19 pandemic, but the practice has been around for more than 6,000 years and is unlikely to stop growing any time soon.

"Biotech stocks offer investors exposure to exciting innovations within healthcare and life sciences," says Andrew Krei, co-chief investment officer of Crescent Grove Advisors. "These companies are often on the cutting edge and lead the development of breakthrough therapies."

The biotech industry is an exciting place to be, but also a risky one. "The upside can be substantial, but new technologies can fail to materialize, wiping out equity values," Krei says.

Successful investing often requires extensive research into the industry and its participants, something few individual investors are likely to have the time or inclination to do. Luckily, there is an easier path that offers a lower risk and lower effort way of investing in the biotech industry: biotech ETFs.

Why should I invest in biotech ETFs?

"There is a lot of risk with individual biotech firms, due to the large R&D capital expenditures necessary to find new patient deliverables, and if a firm misses or doesn't get approval, it can be catastrophic for the business," says Daniel Milan, managing partner and investment advisor representative at Cornerstone Financial Services.

This is why diversification is key when investing in the biotech industry. Biotech ETFs let you invest in dozens or even hundreds of different biotech companies through a single investment vehicle.

"The upside may not be as great when compared to picking a few stocks that experience outsized success, but you can limit the potential downside from owning one or two names that go bust," Krei says.

Biotech ETFs also lets you get exposure to the sector without needing deep expertise in the biomedical fields, Milan adds. ETFs are run by professional money managers who have the time to track the space and keep tabs on each of the healthcare stocks within their portfolio.

How to find the best biotech ETFs 

While using biotech ETFs lets you invest in the industry without needing to know everything about each individual company, you still need to do your due diligence before choosing a fund. There are four areas to focus on when choosing a biotech ETF: fee structure, methodology, liquidity and the portfolio holdings.

With fees, lower is generally better, but sometimes it's okay to pay a little extra for a more hands-on management approach. Aim to keep expense ratios no higher than 0.75%.

Passively managed ETFs are the cheaper option, but be aware of how the index weights its constituents. Market-capitalization weighted indexes put a higher weight on larger companies, which will skew the portfolio towards the largest biotech names. 

"This has historically produced a lower volatility profile but more muted upside," Krei says.

In an equal-weighted portfolio, small companies get the same weight as larger ones. "This generally leads to more upside when smaller names experience success but has led to a higher volatility profile overall," Krei says.

To ensure liquidity, Krei says to look for funds with at least $1 billion in assets under management and trading volumes well over 100,000 per day on average.

As you analyze the portfolio holdings, Milan says to look out for big collaborations that will allow for larger R&D budgets. 

"An example would be CRISPR Therapeutics (CRSP) and Vertex (VRTX) who have a big partnership that goes back to 2015," he says. "These would be identified by Google searches or reviewing quarterly earnings commentaries."

You may also want to look at the company's clinical trial historical data success and cash available for research, he says.

The best biotech ETFs to buy

While best is a subjective term – what's best for your neighbor may not be best for you – the following biotech ETFs are endorsed by experts and worth considering for your portfolio: