An Upstart Biotechnology ETF Right for the Times

If there's anything positive coming from the coronavirus, it's that innovation is perking up. After all, necessity is the mother of innovation and the latter is certainly needed these days.

The exchange traded funds industry is one of the epicenters of pandemic innovation as a spate of new products are being born out of the coronavirus pandemic. Not surprisingly, many of these infant ETFs are healthcare plays, including the newly minted Defiance Junior Biotechnology ETF (IBBJ).

IBBJ debuted last week and tracks the Nasdaq Junior Biotechnology Index. That index itself is new, having launched on April 30, but it's off to a hot start, returning more than 10 percent since inception. The benchmark is “designed to track the performance of a set of securities listed on [Nasdaq] that are classified as either biotechnology or pharmaceutical according to the Industry Classification Benchmark (ICB),” according to Nasdaq Global Indexes.

In the case of IBBJ, “junior biotech” is defined as companies with market values up to $5 billion, so the new ETF's roster of 176 components runs the gamut of companies fitting the bill as micro caps up to small mid-cap names. In less technical terms, IBBJ's basket is comprised of a market capitalization range that, in the biotech space, is historically tricky to stock pick in, but also highly rewarding.

Investment Merit

An interesting fact about IBBJ is that the new fund fills something void. As noted above, smaller biotech stocks, broadly speaking, have illustrious histories of delivering out-performance for investors that can stomach the volatility.

However, prior to IBBJ's debut, there was just one dedicated small-cap healthcare ETF and one fund focusing on biotech names in the $5 billion market cap and below space. Historical data confirm those products have been winners, generating an average three-year return of 52.7 percent compared to a 13.3 percent gain for the S&P SmallCap 600 Index.

Another point in IBBJ's favor is that with a deep bench for a fund addressing this particular niche, it's unlikely the fund's course will be determined solely by happenings on the COVID-19. Said differently, IBBJ, importantly, has a future when the virus is vanquished or a vaccine comes to market.

IBBJ member firms are “companies engaged in biotech research and development, the sale or licensing of biological substances for the purposes of drug discovery and diagnostic development; and pharmaceutical manufacturers of prescription or over-the counter drugs, including vaccines and development and manufacturing companies,” according to Defiance.

One way of looking at that is that while some IBBJ holdings have coronavirus leverage, none of its components have weights exceeding 3.2 percent, meaning single stock risk is minimal, and the fund has the chance to excel in a post-virus world.

Buyers' Paradise

Another source of potential allure, emphasis on “potential,” with IBBJ is that the market cap range of its holdings is one of the sweet spots when it comes to healthcare sector consolidation. On that note, the pandemic is showing big biotech and pharmaceuticals companies that there are value in partnerships if not outright purchases, particularly when the target is a smaller, nimble company with a decent pipeline.

Not all IBBJ components are legitimate takeover targets, but for those that are, there's twofold promise on that front. First, many large-cap, old pharmaceuticals companies are facing major patent cliffs over the next several years.

Second, the 10 largest biotech and pharmaceuticals companies in the S&P 500 had an average cash stockpile of $10.7 billion as of mid-June. That's more than enough to go shopping among IBBJ holdings.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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