Biotech ETFs Come Back Down To Earth

Biotech stocks have been one of the hottest sectors of the market over the last several years and many exchange traded funds have benefitted greatly from their success.

The two largest ETFs in this space are the iShares NASDAQ Biotechnology ETF (NASDAQ:IBB) and SPDR S&P Biotech ETF (NYSE:XBI) -- which have similar underlying companies, but vastly different index construction methodologies.

IBB has nearly $5 billion invested in 123 individual companies that are market cap weighted. This means the companies with the largest market value, such as Amgen (NASDAQ:AMGN) and Biogen Idec (NASDAQ:BIIB), are the largest holdings. In fact, the top 10 holdings in IBB represent nearly 60 percent of the fund's assets.

By contrast, XBI is made up of 84 biotechnology stocks, with an equal weighting methodology that gives each company a similar share of the fund's assets. This means each underlying stock has a stronger representative influence on the total return of the ETF over time.

Despite these fundamental differences, the strength of this industry group has been phenomenal. Through the end of last month, IBB jumped 79.27 percent and XBI gained 74.54 percent over the last 52-weeks. To provide perspective, the broadly diversified Health Care Select Sector SPDR (NYSE:XLV) has gained 39.13 percent over that same timeframe. Investors have clearly been hungry to profit from an industry that is developing cutting-edge solutions to complex medical problems.

As a leader on the upside, biotechnology stocks are a closely watched group, that has started to show the first convincing sign of weakness this year. XBI has now fallen more than 16 percent from its high water mark on a closing basis and IBB has lost 13 percent.

This has, in turn, boosted the ProShares UltraShort NASDAQ Biotechnology ETF (NASDAQ:BIS), which provides -2x the daily returns of the NASDAQ Biotechnology Index. BIS is an aggressive way for ETF investors to profit when the biotechnology sector is falling.

Only time will tell if this recent bearish divergence is the result of biotechnology stocks taking a short-term breather --or if it will be a spearhead for the broader market on the downside. This volatility will certainly be an opportunity for traders to take advantage of, no matter what direction this sector ultimately goes.