To The Moon

While the biotech sector had long enjoyed investors’ attention, it was never as pronounced as around the time the pandemic was felt around the world. However, as 2022 unravels, so has investor interest, with a steady downward trend in stock valuations across the board. 

For a broad analysis of the sector, let’s consider the iShares Biotechnology ETF (IBB) vis-à-vis investor favourite (at least until recently) the ARK Genomic Revolution ETF ($ARK Genomic Revolution Multi-Sector ETF(ARKG)$). For contrast, let’s also examine the AUM and price trajectories of these two vis-a-vis the Invesco Dynamic BioTech & Genome ETF (PBE) and the VanEck Biotech ETF (BBH).

AUM vs Prices: Outflows are generally in excess of price movements

Until 2022, ARKG’s AUM “deltas” relative to prices suggest stronger capital inflows than with the other 3. In 2022, ARKG is witnessing a substantially greater outflow than IBB and PBE while BBH’s AUM suggests that investors are holding steady.

This differential behaviour between BBH and IBB – both with market capitalization-driven constituent selection rules – lie in the “size effect”. Larger companies are expected to be more robust than smaller ones; IBB has in excess of 300 companies of varying sizes while IBB represents only the largest 25. The overall sentiment is clouded by a niggling longstanding investor concern: overvaluation.

For the best representation of the European biotech sector vis-à-vis North America, let’s consider the price-based ratio aggregates of IBB’s constituents. Given ETFs don’t have overall ratios, proximate aggregations of these metrics are carried out in two formats to arrive at an effective proxy for regional contribution:

1. The average; wherein the reported ratios of each of the ETF's constituents are averaged outright;
2. The weighted-average; wherein the reported ratios have each constituent's weight factored in.

The prospect of overvaluation has an interesting effect on these ratios as reported by data services such as Bloomberg: metrics that are too high or too low are not reported as they’re not considered to hold any meaningful information for the investor. Thus, the proportion of tickers with unreported PE ratios relative to total number of tickers is calculated in both regions as well as the ETF in total.

European companies had little contributory effect to sector performance as compared to U.S. companies

The percentage share of unreported Price to Earnings (PE) ratios – signifying them to be too low or high to be meaningful – in both Europe and North America are running at near-par while the outsized Price to Sales aggregates suggests revenues (and not earnings) have heavily influenced the sector’s historical valuations. In the most recent date, 30 of IBB’s 372 constituents were among ARKG’s 49 constituents. Overall, 43 of ARKG’s constituents have unreported PE Ratios.

The massive preponderance of unreported PE ratios in both ETFs is an indicator of how overvalued the biotech sector is. Overvaluation influences volatility which, in the economic picture emerging, makes a continued downward trend more likely than the converse. Morningstar’s Star Rating system as of Q1 assigns ARKG a 1-star rating over a 3-year horizon and 2-star rating over a 5-year horizon. IBB does a little better: 2 stars in 3- , 5- and 10-year horizons.

For equity investors, this sector is increasingly less attractive in the present economic scenario at least until the “floor” become more apparent. Tactical investors who have access to Exchange Traded Products (ETPs) to capitalize on stock trajectories in either direction for short-term plays. For instance, ARG3 and $LS -3X SHORT ARKG ETP(ARGS.UK)$ give +3X and -3X exposure to the daily returns on ARKG respectively while 3IBB and $LS -3X SHORT BIOTECH ETP(SIBB.UK)$ do the same for IBB. Investors could consider building a portfolio supplemented by ETPs (as shown in examples in a previous article that discussed a portfolio strategy centred on Tesla stock) to boost gains during dips in short-term horizons or pursue an outright bearish strategy using the -3X ETPs with active performance supervision.