Biotech ETFs: Buy, Buy, Buy?

Since peaking on July 20, the iShares Nasdaq Biotechnology ETF (NASDAQ:IBB), the largest biotech exchange traded fund, is off 15.2 percent. That is a correction and a half. Biotech sneezing has helped the broader healthcare sector catch a hold.

Over the past 90 days, the Health Care Select Sector SPDR (NYSE:XLV), the largest healthcare ETF and one that allocates more than 20 percent of its weight to biotech stocks, is lower by 8.2 percent. Biotech stocks and ETFs have been plagued by political grandstanding and the almost always present valuation concerns with both scenarios combining for significant headwinds for the sector.

BB's top 10 holdings include well-known biotech behemoths such as Celgene Corporation(NASDAQ:CELG), Amgen, Inc. (NASDAQ:AMGN) Gilead Sciences, Inc. (NASDAQ:GILD). This is a top heavy ETF, meaning the fact that short-sellers are targeting its top 10 holdings is useful information for traders considering an ETF such as the ProShares UltraPro Short Nasdaq Biotechnology (NASDAQ: ZBIO).

IBB is a cap-weighted ETF, resulting in its top four holdings, including the three aforementioned stocks, combining for overa third of the fund's weight. Overall, IBB's top 10 holdings combine for over 60 percent of the ETF's weight, according to issuer data.

Some analysts believe the recent retrenchment experienced by the biotech sector is giving way to a buying opportunity.

Improving Fundamentals

The key takeaway is that despite worries about pricing and biosimilar competition in the U.S., the overall fundamentals continue to improve in the sector given the strong pipeline productivity, according to Morningstar. In addition, given the recent sell-off in biotechs in the last month or so, this is the first time in a number of years where the group, inaggregate, istrading at a discount to our fair value estimates. So, we think it's a good time to get into some high-quality names in the sector.

Amgen is Morningstar's favorite idea among biotech companies it designates as wide moat, or having nearly unassailable competitive advantages. California-based Amgen is IBB's second-largest holding at 8.92 percent, just behind the 8.93 percent allocated to Celgene.

Morningstar also sees Alexion Pharmaceuticals, Inc. (NASDAQ:ALXN), Vertex Pharmaceuticals Incorporated(NASDAQ:VRTX) and Biomarin Pharmaceutical Inc. (NASDAQ:BMRN) as attractively valued. Those stocks combine for 11 percent of IBB.

Among narrow-moat names, several rare-disease companies have been hit by worries about pricing because many of their drugs have price tags of more than $100,000 per year. Nevertheless, we think that the rare-disease space is one of the most attractive niches in the biotech space, adds Morningstar.

Some investors might need convincing about the imminence of a biotech resurgence. After hauling in over $1 billion in new assets during the third quarter, IBB has lost $316.3 million in the current quarter.