By: Chelsea Pratt
Looking to invest in biotech? Cultivate patience first. With product development often taking decades, it’s a waiting game to see whether sizable returns will ever materialize.
Biotech investors should expect to sit with uncertainty for 10 to 15 years, Andrew Casey, president and CEO of BIOTECanada told The Globe and Mail—and that means you’ll want to have confidence in your initial investment strategy.
Below, we outline three ways to invest in biotech and hit on the pros and cons of each.
1. Investing in small companies
It’s true that the number of IPOs in the first quarter of 2016 was far less than in previous years. But of the 10 in the healthcare industry, almost half were in biotech—leading MarketWatch to declare that “this year’s IPOs [were] led by companies with no products or no assets.”
That adeptly sums up the risk of investing in smaller biotech companies: they often have nothing to sell. Editas (NASDAQ:EDIT), for example, went public on February 3, 2016. Despite only having products in the research and pre-clinical trial phase, their stock prices soared—until March, when, as Fortune magazine notes, they fell by almost 26 percent.
This volatility is characteristic of smaller stocks, especially in the already high-risk biotech sector. They are attractive because of their lower cost and potential for high returns—but with that comes additional risk.
2. Investing in large companies
For those less tolerant of risk, investing in large cap biotech companies, like Amgen (NASDAQ:AMGN) or Gilead Sciences (NASDAQ:GILD), might be the better option. Make no mistake: biotech is always a high-risk venture. But when the company has multiple product lines and the funds to cover failed development efforts, their stock is more stable.
Since these companies have been public for longer, there is also more information available about past clinical trial results or company operations and profitability. These criteria are key when researching biotech stocks and predicting their future performance.
Of course, reduced risk and greater transparency come with a trade-off: investors stand to profit less. Well-established larger companies are not as likely to see the kind of explosive growth that sends stock prices skyrocketing.
3. Investing in ETFs
“People become obsessed with an individual biotech stock—that’s a losing game,” Brad Loncar, CEO of Loncar Investments, told US News earlier this year. “People have done that and tried to make 200 and 300 percent on a single stock, and they lose all their money,” he continued. “If you had simply owned the sector, you would’ve made large gains.”
One way to “own the sector”—or at least a broader piece of it—is through exchange-traded funds (ETFs). Similar to mutual funds, an ETF is a collection of holdings that tracks an index or sector—but unlike mutual funds, ETFs trade like a common stock.
Diversification is their greatest selling point. One company’s product might fail in clinical trials—but if the ETF’s other holdings perform well, you can still see returns. The fact that biotech ETFs often bundle their holdings with pharmaceutical or life science securities further reduces the risk inherent to investing in the biotech sector.
It’s also possible to choose ETFs that focus on small or large cap companies, allowing you further control over how much risk you take on. The SPDR S&P Biotech ETF (NYSEARCA:XBI), for example, tracks smaller companies, while the iShares NASDAQ Biotechnology ETF (NASDAQ:IBB) has more mature larger holdings.
The major downside? You’ll need to pay frequent commissions and other management or trading fees, which cut into potential profits.
More research equals less risk
Whatever option(s) you choose, keep this in mind: more research equals less risk. The further along a company’s product is in clinical trials, the greater its chance for success. It’s safest to pick those companies that have reported positive results in phase two or three of testing.
By the same token, conducting ample independent research will increase your odds of making a profitable decision. As with all investments, it’s critical to investigate a company’s financial health and consider managerial performance and stability. But if you opt to invest in biotech, there are a few additional factors to keep in mind. Jonathan P. Gertler, managing partner and CEO of Back Bay Life Science Advisors, told US News that biotech investors need to focus on the “wisdom of the regulatory plan or clinical plan, unmet need in the space [where the company is] attacking and how disrupting or clinically positive the outcome might be.”
Such factors are difficult to assess and analyze, so if you plan to invest in biotech, read widely to ensure you make an informed decision. Why not continue your research with the articles below?
Securities Disclosure: I, Chelsea Pratt, hold no direct investment interest in any company mentioned in this article.