How to Pick the Best Biotech Mutual Funds

Biotech Mutual Funds Definition and Best Funds

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Biotech mutual funds invest in stocks of companies in the biotechnology sector, which is part of the broader health sector of stocks.

Biotechnology was one of the top-performing sectors of 2020. If you're investing for the long term, biotech can be a smart addition to a diversified portfolio. Prices can be volatile in the short term, but biotech funds have historically outperformed markets in the long run.

Key Takeaways

  • Biotech mutual funds are comprised of large and growing biotech companies such as Amgen (AMGN), Gilead Sciences (GILD), and Biogen (BIIB).
  • Fidelity, Rydex, and T. Rowe Price are some of the brokerages offering biotech mutual funds.
  • When you buy into a biotech fund, look at its performance history, risk attributes, expense ratio, and manager tenure.
  • When investing in sector mutual funds, some experts suggest not to invest more than 5% to 10% of your money into one sector.

How to Choose the Best Biotech Mutual Funds

If you're thinking of adding a biotech 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. These include the performance history, risk attributes, manager tenure, and expenses.

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

Performance History

When analyzing historical returns for biotech funds, be sure to focus more on the long-term performance rather than the short-term. This is especially true for actively managed funds. 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 Beta

Along with the potential for high relative returns, biotech funds 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 the volatility of a biotech mutual fund to the market, you can use a statistical measure called Beta. For instance, a Beta of 1.00 means equal volatility to the market. A Beta of 1.20 would mean swings in price 20% higher on the upside and 20% lower than the market. Higher Beta means greater volatility.

Manager Tenure and Alpha

For actively managed funds, manager tenure and Alpha are key statistics to know. For instance, 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's 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. This is 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 key 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 typical expense ratio for health sector funds is around 0.6%.

The best biotech mutual funds will have most or all of these qualities:

  • Above-average long-term returns
  • Long manager tenure (more than five years)
  • Average to below-average market risk
  • 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 to look for.

3 Best Biotech Mutual Funds for 2021 and Beyond

The best biotech mutual funds will have good historic performance in relation to market risk, low expenses, and other factors. Biotech 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 right now:

  1. Fidelity Select Biotechnology (FBIOX): This is 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 March 10th, 2021, FBIOX had a 10-year annualized return of 20.97%. This beat the sector average by 5%. It also crushes the S&P 500 index performance, which had a 13.88% return over the same period. Fund manager, Rajiv Kaul, has been at the helm of the fund since 2005. Expenses for FBIOX are only 0.72%.
  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 16.52% beats other tech funds by almost 3%. The fund manager, Michael P. Byrum, has been at the helm since the inception of the fund more than 20 years ago. Although the expense ratio of 1.47% is above average, the long-term returns have historically justified the cost.
  3. T. Rowe Price Health Sciences (PRHSX): If you want exposure to biotechnology stocks along with other areas of the health sector, consider PRHSX. Biotech stocks make up the largest portion of the fund at 85.67% of assets. Fund managers aim to keep that that allocation to at least 80%. The 10-year return through Dec. 31, 2020, was an impressive 20.49%. The current fund manager, Ziad Bakri, has been at the helm for a little over five years. The five-year return is 14.3%, which beats the benchmark by just over 1%.

Biotech mutual funds typically hold large, growing biotechnology stocks, such as Amgen (AMGN), Gilead Sciences (GILD), and Biogen (BIIB). If you want to add a biotech mutual fund to your portfolio, be careful not to allocate too large of a percentage to just one sector. A good allocation for a sector fund is 5%-10% for most investors. Also note that while biotech mutual funds have historically outperformed the broader market, these funds also carry higher relative risk.

The Balance does not provide tax, investment, or financial services and advice. The information is being presented without consideration of the investment objectives, risk tolerance, or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk including the possible loss of principal.