Strategies For Uncertain Times: biotechnology strategy update

Yesterday Bespoke Investment Group put out a blog post about the strength of health care stocks as of late. The title of their post is “Health Care ETFs Catch Fire” and the link is here: http://www.bespokeinvest.com/bespoke/2009/12/health-care-etfs-catch-fire.html

They attribute the sector’s strength to the Senate’s actions re: the proposed health care bill. I don’t disagree. They note, for example, the strength in XLV (Health Care Select Sector SPDR).

Examining HQH (H&Q Healthcare Investors), their portfolios share a few of their top 15 holdings (3 to be exact), although that’s not a terribly high number and the allocations to each security are not even close.

Between 9/15 and 12/5 (a 3 month period) XLV has returned 10.7% including at 13c dividend paid. During the same period HQH has returned 3% and it’s discount vs. NAV shrunk very slightly to 20.57% from 21.79% (it has not made any distributions). During the same period the PBE PowerShares biotech index has declined 2%.

So… this raises an interesting question: Should we either assume that 1) biotech lags overall health care sector price movements and will catch-up, or 2) does biotech trade independently with a low correlation versus even its parents sector overall, or 3) does biotech have unique challenges that have presented new reasons for investors to be cautious over the last 3 months?

I hypothesize that the correlation is actually pretty low (I keep screwing around with various beta calculations and get something between 0.5-0.6 between HQH and XLV, but these are not concrete numbers). Furthermore, if I examine the holdings of the XLV portfolio and other health care portfolios that have been rocking and rolling as of late, it’s clear that the parent industry portfolios have larger concentrations in the big cap pharma, services, and insurance names (closer direct impact to proposed health care legislation). That said, there is some overlap but the biotech names are smaller and less widely owned. Perhaps they are the less-desirable short-term trading vehicle?

The bottom line is that I don’t have the answer, but I do know that the CEF discount for HQH is still well above its historical average, and as their distribution was already cut a while back, I don’t see much downside in holding shares of the fund. However, the combination of not much downside and an uncorrelated investment makes HQH attractive in my eyes as a piece of an larger portfolio with a overall perspective of Strategies For Uncertain Times.