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Reinventing the wheel: Invest today in tomorrow's technologies

ETFs could be the best way to play nanotechnology, biotech sectors, ROB CARRICK writes

Investors looking for the next big thing, meet the world-renowned economist Richard Lipsey.

Mr. Lipsey is a Canadian who has just co-written a book called Economic Transformations: General Purpose Technologies and Long Term Economic Growth. The book tells us that the computer revolution is coming to a close, and that the next technological transformation will come from biotechnology, which has applications in such areas as health care, food production and industry (example: bacteria that eat pollution). The next revolution after that will be nanotechnology, which is about producing materials and devices that are tiny -- even microscopic -- in size.

To be clear on the importance of biotechnology and nanotechnology, it's worth noting that Mr. Lipsey ranks them on a list of 24 of the greatest technological breakthroughs in history. The list begins in 9000-8000 BC with the domestication of plants and includes the wheel, printing, the steamship, the internal combustion engine, the motor vehicle and the airplane.

The full benefits of biotechnology and nanotechnology may not be felt for years, but there's already an easy way to profit from these sectors using a popular investment vehicle called the exchange-traded fund.

ETFs are basically stocks that represent an interest not in a single company, but in the gamut of companies that make up various stock indexes. You can use ETFs to invest in major indexes such as the S&P/TSX composite and the S&P 500, and to delve into niches like the Nasdaq Biotechnology Index and the Lux Nanotech Index.

Trying to invest in the next big thing when it's still small means big risks and a high potential return. The technology boom of the late 1990s is a definitive example.

Individuals who got in early and judiciously took profits had the opportunity to make huge gains, even though tech stocks were annihilated in the three-year bear market that began this decade. Propelled by computer and Internet stocks, the Nasdaq composite index ran up from 752 to 5,048.62 between the beginning of 1995 and March, 2000. Today, the index is around 2,150.

There's already enough interest in the biotech sector to have generated three ETFs listed on U.S. stock exchanges, all of them easily purchased by Canadian investors through any brokerage firm. The track record of these ETFs highlights the realities of investing in biotechnology today as outlined by Mr. Lipsey.

Biotechnology, he writes in his book, "is sufficiently developed to ensure that it has many potential uses, but not developed enough to allow much beyond informed guesses at some of the revolutionary uses on the horizon. Commercial risks are great because the industry is operating under conditions of genuine uncertainty. Payoffs are sometimes a decade or more into the future and failed research efforts are plentiful."

Translation for investors: Biotechnology could require perseverance.

The largest and most popular biotech ETF is the iShares Nasdaq Biotechnology Index Fund, which tracks the more than 150 stocks in the Nasdaq Biotechnology Index. The fund has gained about 13 per cent in the past 12 months, but this success seems to be an anomaly. It's down almost one-third in total over the past five years, and in 2006 it's down almost 6 per cent.

Don't get the idea that biotech as an entire sector has been a sinkhole because it hasn't. Gilead Sciences Inc. and Teva Pharmaceuticals Industries Ltd., both major components of the Nasdaq biotech index, are up a total 128 and 44 per cent, respectively, in the past three years. Teva is a generic drug manufacturer and Gilead is a biopharmaceutical company with expertise in liposomal drug delivery, where drugs are coated in the same substance that cell walls are made of. The idea is to make the drugs more effectively absorbed into the body.

A defining characteristic of ETFs is that they provide exposure to all stocks in a particular index, winners and losers alike. So for every Gilead, there's an Amgen Inc., a biotech giant with a share price that has fallen about 13 per cent this year and is currently a bit below where it was five years ago.

Today, when biotech is a highly speculative sector with only a few proven players, it's arguably a drawback to have sector-wide diversification. But in a future where biotech is what commodity stocks are to today's market, ETFs will be a much better bet than running the risk of choosing your own stocks.

In fact, there may be no harder sector in which to pick stocks than biotech. It's a much more arduous task to bring a new cancer drug to market than it is to drill for oil or develop a new spin on the MP3 player. Plus, all the scientific and medical jargon can make it difficult for investors and even analysts to understand a company's true prospects.

So which of the various biotech ETFs are best? Answer: the ones that best combine low ownership fees, diversification and liquidity, which means heavy enough trading volumes to ensure that investors can buy and sell at a fair price.

The lowest management expense ratio for biotech funds is the SPDR Biotech ETF, at a very reasonable 0.35 per cent. Also, this fund offers true diversification by giving near equal weightings to each of the stocks in the underlying S&P Biotechnology Select Industry Index. Unfortunately, investors have shunned this ETF to a point where there are days when it often trades no more than a paltry few thousand shares per day. This isn't quite dust and cobwebs, but it's close.

The iShares Nasdaq Biotechnology Index Fund has an MER of 0.5 per cent and offers the best liquidity of any biotech ETF. However, it weights its stocks according to market capitalization, which means that Amgen, Gilead and Teva together account for about 27 per cent of its returns. This is fine if you're supremely confident about those companies, but it's not ideal if you want broadly diversified exposure to biotech.

The PowerShares Dynamic Biotechnology & Genome Portfolio has the highest MER at 0.63 per cent and decent liquidity. It limits the size of its holdings to no more than about 5 per cent, so you get fairly equal exposure to the 30 stocks it holds.

If the SPDR fund were to catch on with investors, it would be a top choice because of its low fee. For now, though, the PowerShares and iShares funds are better options.

An alternative to biotech ETFs is the Biotechnology HOLDR, which stands for holding company depositary receipt. HOLDRs are like a basket holding actual shares in a variety of stocks in a sector. You can vote your shares, receive dividends on them and sell them at will. A downside is that you have to buy round lots of 100, and the unit price for biotech HOLDRs these days is around $174 (U.S.).

It's a much easier call if you want an ETF to invest in nanotechnology, which Mr. Lipsey believes will have its day after biotech. That's because the only choice is the PowerShares Lux Nanotech Portfolio, which tracks an index of 26 stocks created by a consulting firm specializing in nanotech called Lux Research.

The Lux index comprises a mix of established companies such as Toyota Motor Corp., BASF AG and E.I. du Pont de Nemours & Co., as well as comparative unknowns like Veeco Instruments Inc., which sells equipment used in production of microelectronics, and Headwaters Inc., which specializes in ways of making more efficient use of fossil fuels such as coal. The Lux Nanotech ETF is up close to 20 per cent since it was listed last October, which isn't bad for a sector that is still waiting in the queue to be the next big thing.

Buying a breakthrough

Economist Richard Lipsey has identified biotechnology and nanotechnology as being in line to have the same impact on the world as cars, airplanes and computers. Here are some exchange-traded funds listed on the American Stock Exchange that offer a convenient way to invest in these two sectors of the future.

FundSymbolMERCurrent Price*Return YTD
Biotechnology HOLDRsBBHnone$174.11 - 13.3%
iShares Nasdaq BiotechnologyIBB0.5$72.83 - 5.7
Index Fund
PowerShares Biotechnology PBE0.63$16.21 - 6.6
& Genome Portfolio
PowerShares Lux PXN0.63$17.38 +6.0
Nanotech Portfolio
SPDR Biotech ETFXBI0.35$44.84 - 6.2

*prices are to June 8/06, and in U.S. dollars

Investors are charged $2 (U.S.) per 100 HOLDR units each quarter, to be deducted from dividends and other cash distributions.

© 2007 The Globe and Mail. All rights reserved.

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