Andy Hagans sits down for an interview with Paul Yook, the founder of BioShares ETFs.
ETF Reference editor in chief Andy Hagans recently interviewed Paul Yook, co-founder of LifeSci Index Partners and the portfolio manager for BioShares funds. Mr. Yook previously worked as a healthcare hedge fund portfolio manager and equity research analyst at Galleon Management. The interview was completed over email in May of this year.
Andy Hagans: Your firm, BioShares, has developed some of the most targeted ETFs available today. How did the idea for these products come to be?
Paul Yook: Before we launched our two BioShares index funds in December 2014, there were five biotech ETFs in existence, each a passive, index-based fund. My partners and I have been in biotech for nearly two decades as investors, scientists, and research analysts. When we looked at those funds mostly created by larger firms without biotech specialization, we saw some ways to improve these already good products.
The first step is to include only pure biotech companies in our portfolio and exclude generic drugs, medical device and equipment manufacturers, and other non-biotech companies, accounting for up to 30 percent of the allocations in these other biotechnology indexes.
The second step is that we then split this pure biotech universe into “Products” companies and “Clinical Trials” companies. Our BioShares funds are the only ETFs that make this distinction, and we have found that these groups actually have very different financial characteristics and stock market performance. So for the first time, investors can decide which biotechnology group they prefer. For example, we find that some retired investors prefer our BBP Products fund, as it has arguably lower volatility and risk. And we find that some younger investors looking at longer-term time horizons prefer the younger biotechnology companies in our BBC Clinical Trials fund and are willing to accept higher risk and volatility.
The third step is to equally weigh our portfolio as opposed to market cap weighting – and this goes back to Fama and French’s Nobel Prize-winning work that, in general, smaller-company stocks tend to outperform larger company stocks over time. This isn’t unique to our funds, but it is particularly important in biotechnology because there is a very large market cap disparity between the largest companies at well over $100 billion market cap and the numerous smaller, dynamic companies with market caps at $1 billion or lower.
Andy Hagans: There are more than 150 biotech stocks listed on the NYSE and Nasdaq. I think you’d argue that even further segmentation is needed here – that there are actually very different types of biotech stocks. Can you explain that a bit further?
Paul Yook: There is a new index recently announced — the Loncar Cancer index — which tracks immuno-oncology, which is probably the hottest area in biotech today. This index is likely to generate significant interest as a stand-alone ETF. But beyond that, I don’t believe there many other sub-segments in biotech that would be large and interesting enough to support a stand-alone ETF. For example, some of the other hot areas (such as gene therapy, companion diagnostics, rare diseases, and biosimilars) are either too small or don’t have enough stocks. And other interesting disease categories (such as neurological disorders, infectious diseases, and cardiovascular) may not provide differentiated or superior returns from the overall biotech group. Also, companies often blur lines between categories and rarely can be neatly placed in one bucket or another.
The truth is, no one knows what will be hot in this space in 10 years and what will fail. For example, gene therapy, which was thought by many to be destined for failure a decade ago, is now a very hot segment again with exciting results (e.g., BLUE, ONCE). Conversely, stem cells and regenerative technology garnered large amounts of private and public funding a decade ago but have largely failed to deliver. The beauty of investing in a broad biotech ETF, which invests across different diseases, large and small drug markets, older and young patients, and in newer and more established companies, is that investors stand to benefit from all advances in the sector.
Andy Hagans: What’s the investment thesis for an overweight position in biotech now, after this sector has delivered huge returns in the last couple of years? What is going to drive future growth?
Paul Yook: Broadly, the biotech sector had positive but unspectacular risk-adjusted returns in 2009, 2010, and 2011. It really has been 2012 through now that returns have handily exceeded the broader markets. This is a result of a record number of new FDA drug approvals, financial results exceeding Wall Street estimates, and continued buyouts of biotech companies by larger pharmaceutical players.
In our opinion, each of these trends is likely to continue. One can argue that the pace of scientific advancement and understanding of human biology is actually accelerating. Given the successes in this industry, research funding is more available than ever — from the government and from investment funds. Even after huge improvements in mortality rates, with great contributions from the biotech sector across diseases such as HIV, hepatitis C, breast cancer, and cystic fibrosis, there are many more disease categories with large unmet medical needs.
So for medium to long-term investors, we believe biotechnology is very attractive. For short-term investors, it’s always tricky, and we can’t predict what stock prices will do this month or this year.
Andy Hagans: In a recent interview with Steven Halpern, you said that biotech stocks are not in a bubble, but they are trading near the higher end of their historical range. Should new biotech investors wade in slowly?
Paul Yook: For higher volatility growth-oriented funds like BioShares, I think it is good to buy on pullbacks and to purchase a little bit at a time.
Andy Hagans: The pace of ETF launches continues to be brisk; do you believe there are any other spaces beyond biotech that are ripe for novel specialized sector ETFs?
Paul Yook: There are some great sub-sector fund ideas out there — I like the HACK cybersecurity fund and the TAN solar energy fund — and there probably are many more ideas to come. But at our firm (LifeSci Partners), we try to keep it simple and specialize in healthcare and biotechnology.