The Number Biotech Bargain Hunters Have to Watch - http://on.wsj.com/1jXjd3E
Investors hunting for a rally should be wary of fund outflows
Buying the biotech dip might not be so smart this time around.
Over the past five years, batterings of biotech stocks have proved good times to wade into the sector. The stocks quickly regained their composure and continued a long march upward.
Now, though, the sector is weighed down by a host of factors such as the controversy surrounding high prescription-drug prices. And asset flows within biotech funds could prove an additional burden.
The Nasdaq Biotechnology Index peaked in mid-July and has fallen 22% since then. That invites comparisons with other selloffs. Investors who recall the March 2014 drawdown, also triggered by a drug-pricing scare, may be especially tempted to buy. That time, the index briefly plunged 20% before resuming a torrid bull march. Those who sold missed out on a significant rally.
But investors considering perceived bargains ought to consider the role that pooled investment vehicles, such as exchange-traded funds, have played in fueling the sector’s bull market. Because biotechs tend to be growth companies that don’t generate reliable cash flows, investor sentiment—and the momentum it can generate—is a critical driver for the stocks.
At the end of July, for example, pure biotech ETFs reported $19.5 billion in assets under management, according to Morningstar data. That marked quite a peak.
At the end of 2012, biotech ETF assets were just $3.3 billion. The heady rise was supercharged by investors pouring $7.4 billion into such ETFs in the first seven months of this year. As money flowed into these funds, prices of the funds’ holdings inevitably rose.
But as the biotech correction began, so did outflows. As of Sept. 30, biotech ETF assets amounted to just $14.9 billion, a nearly 25% fall. August and September outflows of $2.9 billion and $1.8 billion, respectively, were the largest flows on record in either direction.
Mutual-fund flows reveal a similar pattern. Assets in biotech funds rose to $25.7 billion at the end of July, versus just $3.7 billion at the end of 2012. By the end of September, assets had dropped by about 12%, to $22.7 billion, according to Morningstar.
Granted, fund-flow data are backward-looking. So the recent outflows don’t necessarily mean another significant market plunge is in the cards. Unless the outflows slow, though, this will keep up the pressure on biotech stocks.
And the aggressive inflows of 2015 represent an overhang for the market. “This makes for a lot of trapped money, having been deployed at higher prices that will now offer…additional resistance,” writes Jean Fonteneau, manager of a growth-oriented private investment trust.
The change in sentiment is all the more worrying due to what have often been eye-watering valuations for biotech companies with highly uncertain prospects. Add in the political uproar over drug pricing and the fund outflows, and biotech stocks are being hit with a furious one-two-three combination punch. Investors might keep seeing stars for a while yet.