How to Pick the Best Biotech Mutual Funds

Biotech Mutual Funds Definition and Best Funds

investment research_newspaper
••• Learn more about biotech funds and which ones are the best. Getty Images

Biotech mutual funds invest in stocks of companies in the biotechnology sector, which is part of the broader health sector of stocks. Biotechnology is one of the top performing sectors of 2018 and can be a smart addition to a diversified portfolio for long-term investors. Although prices can be volatile in the short term, biotech funds have historically outperformed markets in the long run.

How to Choose the Best Biotech Mutual Funds

If you're thinking of adding a biotechnology sector fund to your portfolio, there are a few things you should know before you buy.

As with investing in any other mutual fund or exchange-traded fund (ETF), it's important to understand some of the basic facts and features of the fund, such as the performance history, risk attributes, manager tenure (if applicable), and expenses.

Here's what to look for when buying biotech mutual funds:

  • Performance HistoryWhen analyzing historica returns for biotech mutual funds, be sure to focus more on the long-term performance, such as 5- and 10-year annualized returns, rather than short-term performance. This is especially true for actively-managed funds because even the best fund managers often have at least one year of poor performance out of every five. For index funds and ETFs, just be sure the fund tracks the performance of its benchmark.
  • Mutual Fund BetaAlong with potential for high relative returns, biotech funds generally have higher market risk than the broad market indices, such as the S&P 500 index. This means greater price volatility (ups and downs). To compare volatility of a biotech mutual fund to the market, you can use a statistical measure called Beta. For example, a Beta of 1.00 means equal volatility to the market. A Beta of 1.20 would mean swings in price 20 percent higher on the upside and 20 percent lower than the market. Higher Beta means greater volatility.
  • Manager Tenure and Alpha: For actively-managed funds, manager tenure and Alpha are important statistics to know. For example, if you find a top-performing biotech fund and it has an outstanding 10-year return, you'll want to be sure the manager has been with the fund for 10 years. If the manager tenure is shorter than 10, the new manager can't receive full credit for the performance. Also, a positive Alpha means the manager adds value with performance that is better than the fund's Beta would predict.
  • Expense Ratio: In the world of mutual funds, expenses matter because higher costs can translate into lower returns, especially in the long run and for certain types of funds. With index funds and ETFs, lower expenses are crucial because there is no active management to justify higher costs. For actively-managed biotech mutual funds, only consistently superior performance would justify higher expenses. The average expense ratio for health sector funds is 1.37.

In summary, the best biotech mutual funds will have most or all of these qualities: above-average long-term returns, long manager tenure (more than 5 years) average to below-average market risk, and below-average expenses. This is especially true for most actively-managed biotech funds. For biotech index funds and ETFs, low expenses are the most important thing quality to look for.

3 Best Biotech Mutual Funds for 2018 and Beyond

The best biotech mutual funds will have a combination of good historic performance in relation to market risk, low expenses, and other factors. Biotechnology stocks and funds tend to have above-average returns but they also have above-average market risk. To show you how to pick the best biotech mutual funds, we researched dozens of funds to arrive at the top three.

In no particular order, here are three of the best biotech mutual funds to buy for 2018 and beyond:

  1. Fidelity Select Biotechnology (FBIOX): One of the only actively-managed biotech mutual funds on the market, FBIOX is strong on three of the most important fund selection criteria, which are performance, expenses and manager tenure. Through July 31, 2018, FBIOX had a 10-year annualized return of 15.85 percent, which beat more than 75 percent of its biotech sector peers and crushes the S&P 500 index performance, which was 10.7 percent for the same period. Fund manager, Rajiv Kaul, has been at the helm of the fund since 2005. Expenses for FBIOX are only 0.74 percent.
  2. Rydex Technology (RYOIX): This biotech mutual fund has been around since 1998, which provides a long history to review. The 10-year return of 14.8 percent beats three-fourths of other biotech funds and the fund manager, Michael P. Byrum, has been at the helm since inception of the fund more than 20 years ago. Although the expense ratio of 1.37 percent is above average, the long-term returns have historically justified the cost.
  1. T. Rowe Price Health Sciences (PRHSX): Investors who want exposure to biotechnology stocks combined with other areas of the health sector, such as pharmaceuticals and medical devices, will want to consider PRHSX. Biotech stocks make up the largest portion of the fund at 36 percent of assets. The 10-year return through July 31, 2018, was an impressive 17 percent, however, the current fund manager, Ziad Bakri, has been at helm for a little over two years. However, the 3-year return, for which he receives most credit, is 5.5 percent, which beats two-thirds of health sector funds.

To summarize, biotech mutual funds typically hold large, growing biotechnology stocks, such as Amgen (AMGN), Gilead Sciences (GILD), and Biogen (BIIB). Investors wanting to add a biotech mutual fund to their portfolio should be careful not to allocation too large of a percentage to just one sector. A good allocation for a sector fund is 5-10 percent for most investors. It's also important to note that, while biotech mutual funds have historically outperformed the broader market, these funds also carry higher relative market risk.

Disclaimer: The information on this site is provided for discussion purposes only, and should not be misconstrued as investment advice. Under no circumstances does this information represent a recommendation to buy or sell securities.