The last decade was one of the best in stock market history.
It featured the longest uninterrupted bull market, and with the S&P 500’s 30.43% rise in 2019, the decade finished with a boom.
For the market, this decade has been off to a great start too, with the S&P 500 up 16.26% in 2020.
No question, we’ve had a heck of a run for a long time.
But investors who have focused on the biotechnology sector have done even better.
Just look at how biotech has crushed the S&P 500 over the long term.
The 495% increase in the iShares Nasdaq Biotechnology ETF (Nasdaq: IBB) since 2010 has more than doubled the S&P 500’s bull run.
Clearly, this is a sector that investors should have knowledge of.
Yet many don’t.
Biotech companies develop drugs and diagnostic compounds for the treatment of diseases and medical conditions.
While a pharmaceutical company already has successful drugs in the market, a biotech company is focused on developing something new.
Biotech is about making huge breakthroughs. It’s an exciting and risky business to be in.
It’s full of home run swings, not base hits.
And in 2020, biotech really hit center stage with investors.
With the pandemic raging, several biotech companies, like Moderna (Nasdaq: MRNA) and Novavax (Nasdaq: NVAX), have taken a leading role in developing COVID-19 vaccines.
These previously unheard-of companies have now become household names.
But the biotech sector is much more than just a COVID-19 trade.
As the chart above shows, biotech is no short-term phenomenon…
A Great Diversifier
Biotech’s long-term outperformance is reason enough for investors to be interested.
But I also love the fact that biotech stocks have little correlation to the movements of the overall market.
Biotech stocks are known as “event-driven” securities.
These companies’ success isn’t driven by whether or not the economy is booming.
Their success is driven by the results that they are having in the lab. If a company makes a breakthrough, its shareholders will be rewarded no matter what is happening in the economy or market.
That is why this sector always outperforms during recessions and market collapses.
I recall biotech being a rare calm port in the storm during the 2008 financial crisis.
When Lehman Brothers failed on September 15, 2008, the biotech sector was actually still up on the year.
Through the entire stock market collapse in 2008 and 2009, the biotech sector outperformed the market by 20% to 30%.
As the world panicked, investors with some allocation to biotech had peace of mind.
My Favorite Way to Play the Sector Is Equally Weighted
The iShares Nasdaq Biotechnology ETF is the largest biotech exchange-traded fund (ETF).
It holds almost 300 different stocks that range in size from microcaps with $100 million valuations to Big Pharma companies valued up to $140 billion.
Its weighting is scaled to match the size of each stock’s market valuation.
That means the larger companies get the biggest portfolio weightings – and therefore, the ETF is dominated by the big boys.
I prefer an equally weighted biotech ETF – one where a stock with a $100 million valuation has the same portfolio weighting as a stock with a $140 billion valuation.
I prefer this approach because the really big winners in biotech come from small companies that hit it big.
The ETF that I believe works best for this is the SPDR S&P Biotech ETF (NYSE: XBI).
This ETF holds an equally weighted portfolio of 173 different biotechs with market valuations ranging from tiny to massive. All of these stocks – not just the big ones – have an impact on performance.
As you can see in the chart above, the equally weighted SPDR S&P Biotech ETF has soundly trounced the iShares Nasdaq Biotechnology ETF over the long term.
And both biotech ETFs have vastly outperformed the S&P 500.
Without question, biotech deserves a spot in your diversified portfolio.
I would caution, though, that like the overall market, this sector has had an incredible run and is overdue for a bit of a rest.
But also like the market, the biotech sector is home to plenty of big winners for investors who are willing to roll up their sleeves and dig them out.