logo

Biotech stocks are tracking for their best quarter ever — here's how to play it

VIDEO3:1603:16
How you should trade the biotech ETFs

Biotech stocks took a tumble Monday with the XBI S&P biotech ETF and IBB Nasdaq biotech ETF each falling by more than 1 percent.

Even so, the two ETFs remain sharply higher for the year. The equal-weighted XBI ETF has rallied 26 percent in 2019, tracking for its best quarter ever, while the market-cap weighted IBB ETF has gained 18 percent.

David Nadig, managing director of ETF.com, said if an investor wants exposure to biotech, one of those ETFs stands above the other.

"If you're playing biotech, you're counting on little companies doing something amazing and hopefully getting bought by a big company," Nadig said Monday on CNBC's "ETF Edge." "We saw that in the last couple of weeks when Spark Therapeutics got bought by Roche, that was a significant position in XBI. It's barely in IBB."

Spark Therapeutics is up nearly 190 percent this year. While it only has a $4.27 billion market cap, it holds a 3 percent weighting in the XBI ETF.

"So if you want those small-cap winners, you have to go with something that's equal weighted," added Nadig.

To Ben Johnson, director of global ETF research at Morningstar, the equal-weighted XBI ETF offers big returns, but volatility in the biotech segment means investors need to have a strong stomach.

"I think if you're going to take a punt on this sector, to spread your bets evenly in an equal weighted portfolio is probably not that bad of an idea," Johnson said Monday on "ETF Edge." "But, understand that you're going to get more exposure to smaller names which are going to be even more volatile within an industry that is incredibly volatile to begin with so load up on those tums."

While the XBI ETF is up 26 percent this quarter, it tumbled 25 percent in the fourth quarter of 2018. In fact, in the past year, the ETF has closed more than 3 percent higher or lower more than 30 times.

"Unless your name is Marty McFly, you're probably not all that well-suited to be playing the biotech space," added Johnson. "I would suggest that if you own a broad U.S. stock market ETF like ITOT, SCHB, or VTI, that you've already got 3 percent of that portfolio that's exposed to the segment. ... Just let the market do the heavy lifting for you."

The ITOT S&P U.S. stock market ETF, SCHB U.S. broad market ETF and VTI Vanguard total stock market ETF have all added more than 12 percent this year.