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FBT Was +47.55% In 2014 And +10.00% YTD. Will The Returns Continue In 2016?

Summary This established Biotech ETF has an interesting structure but also is quite volatile. With $3.28BLN in assets, will the institutions continue to invest in 2016? We answer these questions and provide our recommendation on this top performer. The First Trust NYSE Arca Biotechnology Index ETF (NYSEARCA: FBT ) is an equal weighted passively managed fund with an established track record, (inception 06/19/2006). The fund seeks to replicate as close possible, before fees and expenses, the price and yield of the NYSE Arca Biotechnology Index, (previously the Amex Biotechnology Index). The interesting structure of the ETF is the 30 components, (previously 20 components prior to October 20, 2014). What is challenging for shareholders is the quarterly rebalancings that occur in late January, April, July and October. Due to the equal weighting objective of the Fund and the underlying Index and the general small to mid-cap nature of the sector, these rebalancings and the ETF, in general, can be volatile. We will analyze the structure of the ETF, its holdings, performance and fees and provide our recommendation. 100% of the ETF is in common equity holdings. Our Market Cap is quite simple, with most of our sources agreeing: FBT Market Capitalization Market Cap Weight Mid cap 34.98% Small cap 33.10% Large cap 31.98% These numbers were courtesy of Fidelity, with xtf.com extremely close in agreement. Morningstar, as we previously noted uses a slightly difference nomenclature. Their breakdown is: Medium at 40.56%, Small at 27.19%, Large at 23.12%, and Giant at 9.12%. Categorically we can state that the majority of the firms in this ETF are small to mid-cap firms with limited products presently, if any, in the marketplace. In terms of the style of the underlying components, it is quite clear to investors who have participated in this space. FBT Ownership Style Style Weight Growth 59.80% Pure Growth 30.00% Blend 7.10% Value 3.10% Without a doubt this ETF is a growth vehicle and not intended for those seeking value investments. Morningstar states that the ownership style is mid or medium and is considered high growth. In terms of currency and countries of the holdings it is somewhat interesting. FBT Country and Currency Exposure Country Weight Currency Weight United States 89.90% United States dollar 89.90% Ireland 3.68% Euro 10.10% Spain 3.23% NA NA Netherlands 3.19% NA NA Our country and currency exposure here is clearly US geographically focused with some Eurozone exposure as noted. The 10.10% euro weighting will not adversely impact this ETF even with the euro possibly moving below dollar-euro parity. As such, we have no issues with the underlying geographical or currency weightings. It is quite clear that the overall sector is 100% healthcare in FPT. The industry exposure is informative. Industry Weight Biotechnology 79.27% Life Sciences Tools & Services 16.29% Pharmaceuticals 4.47% While this is in no way diversified, it does show that there are companies within the ETF which are not pure biotech, but are grouped within the fund. Some of them we do recognize from previous research and there is one firm that we previously analyzed and recommended. We will discuss this firm when we review the holdings. In terms of the holdings, as usual we will analyze the top 15 components, their symbols, ratings, (Moody’s and S&P), if any, and their weight within the ETF and the underlying index {BTK}. In this fund’s case we will also show their individual year to date and 12 month performance. FBT top 15 holdings Name/Symbol YTD perf/ 12 month Ratings, (Moody’s/S&P) Weight-BTF Weight- Index, {BTK} Nektar Therapeutics (NASDAQ: NKTR ) 0.71%/-3.27% NR/NR 4.47% 3.33% Dyax Corp. (NASDAQ: DYAX ) 165.50%/168.18% NR/NR 4.10% 3.33% Isis Pharmaceuticals, Inc. (NASDAQ: ISIS ) -7.92%/-0.25% NR/NR 4.09% 3.33% Alnylam Pharmaceuticals, Inc. (NASDAQ: ALNY ) 0.74%/-8.18% NR/NR 3.93% 3.33% United Therapeutics Corp. (NASDAQ: UTHR ) 20.08%/16.21% NR/NR 3.78% 3.33% Celldex Therapeutics Inc. (NASDAQ: CLDX ) -16.33%/-17.19% NR/NR 3.70% 3.33% Alkermes, PLC (NASDAQ: ALKS ) 22.49%/22.62% Ba3/BB 3.68% 3.33% Illumina, Inc. (NASDAQ: ILMN ) -4.60%/-7.27% NR/BBB 3.64% 3.33% Charles River Laboratories International, Inc. (NYSE: CRL ) 18.73%/18.41% Ba2/BBB- 3.57% 3.33% Novavax, Inc. (NASDAQ: NVAX ) 36.09%/46.99% NR/NR 3.48% 3.33% Alexion Pharmaceuticals, Inc. (NASDAQ: ALXN ) -3.18%/-9.12% NR/NR 3.35% 3.33% Myriad Genetics, Inc. (NASDAQ: MYGN ) 25.54%/21.89% NR/NR 3.35% 3.33% Vertex Pharmaceuticals Inc. (NASDAQ: VRTX ) 2.52%/2.02% NR/NR 3.35% 3.33% Regeneron Pharmaceuticals, Inc. (NASDAQ: REGN ) 33.24%/25.67% Baa1/NR 3.32% 3.33% Amgen Inc. (NASDAQ: AMGN ) -0.62%/-5.91% Baa1/A 3.24% 3.33% The top 15 holdings represent 55.05% with an average of 3.67%, with the bottom 15 totaling 44.96%. This was expected with the equal weighting of the ETF. Unlike the index which is even at 3.33% or 1/30 for each holding, the ETF is adjusted for share price and an equal value. Based upon the individual performance of the top 15 holdings, it is fairly obvious that returns are not reasonably predictable without extensive analysis of each company, their future products and FDA approval developments. The equal weightings here do provide an opportunity of participating in one of the top performers, such as Dyax Corporation with a 165.50% return YTD. Obviously, the return on Dyax far outweighs the negative return of a firm such as Celldex Therapeutics at -16.33% YTD. The benefit of the ETF allows participation in a sector where returns can be quite diverse from one firm to another. In terms of credit ratings, only 14.13% (S&P) of the top 15 have ratings and only 25.66% of these 15 holdings. It is quite apparent that with the rapid growth and negative balance sheets of these firms, the majority of the firms are mostly lower grade credits, if rated at all. Only Illumina, Inc., Charles River Laboratories International, Inc and the well known Amgen Inc. are investment grade, as per S&P. One of the firms in the ETF with a weighting of 2.91% is our personal favorite, Quintiles Transnational Holdings, Inc (NYSE: Q ), a company we had previously analyzed and recommended. Quintiles is the leader in {CRO} services or a Contract Research Organization. The company basically performs many of the services that large pharmaceuticals and Biotech firms require to bring their product to market and to continue to develop new and existing products. This would include Consulting Services, Portfolio and Strategy Planning, Clinical Trial Execution, Laboratories, Real-World and Late Stage Trials, Technology Solutions, Patient and Provider Engagement, Product Marketing and Sales. We are a little surprised to see it in this ETF. It is a profitable and quite a large capitalized firm, yet it will continue to grow and profit as long as there is a need for their services from the healthcare sector. As such, we think it is a great way to participate in the overall growth of the firm (14.51% YTD/18.26% 12 month) balanced with the performance of the other holdings in the ETF. Based upon the components and structure we analyzed the overall performance of the ETF and the index. FBT’s Performance, Fees and Recommendation Category FBR {ETF} BTK {Index} Net Expense Ratio .58% NA Turnover Ratio 58.00% NA YTD Return 9.94% (11/30/15) 5.99% (12/07/15) 10.66% (11/30/15) 5.48% (12/07/15) 1-Year Total Return 10.08% (11/30/15) 5.56% (12/07/15) 10.79% (11/30/15) 5.58% (12/07/15) Dividend Yield/SEC Yield 0.17%/-0.43% NA Beta (Shares/Holdings) 1.13/.70 NA P/E Ratio FY1/current 29.60/26.93 NA Price/Book Ratio FY1/current 8.00/7.06 NA Our expense ratio is in-line with the asset class median of 0.53% and is quite acceptable. Our turnover ratio is only slightly surprising here. With an asset class median or 18.00%, we expected much higher. One of the reasons is the general nature of the sector and the rules of the ETF and the underlying index that cause firms to be replaced. According to the NYSE Arca: Components will be removed from the index during the quarterly review if they fail any of the criteria below: (1) Current Market Capitalization is lower than $900 million (2) The Average Daily Traded Value for the past 3 Months is lower than $900,000 (3) The Current Last Traded Price is less than $1.00 In addition, various corporate actions may cause the stocks in the index to be substituted. As there has been M&A activity and various other corporate actions in the sector over the past year, the high turnover ratio is to be expected here. In terms of the ownership of the ETF, it is readily apparent that institutions and funds hold large holdings. While Wells Fargo (NYSE: WFC ) holds 6.31% and Morgan Stanley Smith Barney LLC (NYSE: MS ) holds 8.81%, the big surprise holding is another ETF that we previously analyzed and recommended. The First Trust Dorsey Wright Focus 5 ETF (NASDAQ: FV ), holds 33.99% of the total shares in its ETF or 24.20% of the total assets. The ETF has performed well due to its allocation in FBT, among others. FBT will continue to attract institutional shareholders and advisory clientele who seek allocation to the Biotech sector, regardless of economic conditions. In terms of economic conditions, many consider Biotech as being within the Pharmaceutical and medical space and defensive. We tend to agree, yet the cost of capital for the industry is always a concern. With interest rates set to rise this may be an issue for those firms which tend to borrow heavily to fund R&D. As such, though we are impressed with the performance over the past year the ETF is not for the squeamish. It is noted above that the YTD performance has dropped 4.00% since the end of November. The sector and its holdings are not for investors who are looking for the short term. A dollar cost strategy may be appropriate for investors who are familiar (or not familiar) with the frequent market routs. In terms of FBT the year high on July 20,2015 was $132.21 representing at that time a 28.96% YTD return, while the year low of $64.08 set on August 24,2015, after the Asia sell off, represented a loss of -37.49% YTD at that time. Overall, the volatility of the sector has not dissuaded institutional investors, (or speculators for that matter) from participating in this ETF or the sector. As the second largest biotech ETF, after the iShares Nasdaq Biotechnology ETF (NASDAQ: IBB ) it continues to represent an attractive vehicle to participate in a sector that will continue to produce new drugs and redevelop existing treatments. We are a strong buy on this ETF into 2016 and beyond.

Is XIV The Place To Be If Markets Stabilize And Volatility Declines?

Summary This large ETN is close to its year low and has lost 43% over the past year. As a play on a quiet fall market, is there money to be made when the VIX goes lower? We do an analysis of this heavily traded ETN and answer these questions and more. The VelocityShares Daily Inverse VIX Short-Term ETN (NASDAQ: XIV ) is a rather simplistic (on the surface) security to take advantage of a fall in volatility. According to the sponsor, VelocityShares, The ETNs are medium-term notes of Credit Suisse AG (“Credit Suisse”), the return on which is linked to the performance of either the S&P 500 VIX Short-Term Futures™ Index ER or the S&P 500 VIX Mid-Term Futures™ Index ER (each such index, an “Index” and collectively the “Indices”) The ETNs do have a maturity date of December 04, 2030 but for all intents of purposes the maturity only represents a future date for the instrument to be redeemed or perhaps extended. The ETNs pay no interest and there may or may not be a return of principal upon maturity. A majority of investors in this ETF use the vehicle to hedge against lower volatility. The turnover of only 2 days is indicative of this factor. We will analyze the basic structure and provide some of the key risk factors of this instrument that has seen a significant inflow of funds over the past month. A recent overall structure was quite simplistic: XIV Structure, as of September 10 Contract name Weight CBOE Short-term VIX Future Sept 2015 17.00% CBOE Short-term VIX Future Oct 2015 83.00% As noted, with only 17.00% of the futures contract focused on September, the balance now shifted to October one has an opportunity to participate in lower volatility. The underlying question is, is it that simple? Simply by waiting five days we find it is hardly that simple. Here is the revised structure five days later: XIV Structure, as of September 15 Contract Name Weight CBOE Short-term VIX Future Oct 2015 100% The October contract closed at 23.85 on September 10 and at 20.425 on September 15. All contracts from September have now been rolled over to the current month. As many analysts have stated simply the way VIX contracts are priced, investors will gain approximately 5.00% or more a month on the roll-over. This sounds fantastic and would appear to be a simple way to pick up a very nice return. There are multiple issues why this is not that easy or simple. Since this ETF functions as an inverse to the S&P 500 VIX and is really a short vehicle for the VIX in an ETN form the fund managers in Switzerland via their model and the prospectus must buy contracts that are about to expire and sell the next month. This would be defined as a contango strategy. As such, as noted, XIV may very well gain 5% or more per month simply by rolling future contracts (buying back the ones that are about to expire and sell the next month. The ETN must maintain a short position and bias at all times. The only problem is that not only will the fund lose money during market corrections but also when markets move sideways. These sideway moves occur during political gridlock, holiday periods, Federal Reserve indecision, economic malaise, and during electoral seasons, (in general) to name a few. One of the other problems is that the daily indicative value may be higher or lower than the closing price. As such, an investor can go to sleep believing they could not possibly lose money since the market is rallying overseas, while in fact they lose $.50 per share upon market opening. Fortunately, the share price over time has outperformed the indicative prices and the NAV. Presently the indicative price is $28.08 versus a closing price of $27.75 on September 15, according to Velocity Shares. The one month premium average to the NAV or indicative price has been .78%, reflecting the recent market correction. Many times, (including the presently) it trades at a discount. In terms of the market correction, here are some historical prices and percentage changes on XIV and since August 01 (using XIV closing prices and VIX settlement prices): Date XIV Price C hange Percentage Change VIX Futures Prices Sept/ Oct Change Percentage Change Aug 03, 2015 $48.76 NA NA 15.125 15.875 NA NA Sept 01, 2015 $22.01 -$26.75 -54.86% 29.725 25.825 14.60 9.95 96.52% 62.67% Sept 15, 2015 $27.75 -$21.01 $5.74 -43.08% 26.07% 22.575 20.425 7.45/-6.97 4.55/-5.40 49.25%/-23.46% 28.66%/-20.90% Note: The second numbers listed under change and percentage change are intermediate price changes, (since September 01). As noted above XIV has recouped 26.07% since September 01 and is climbing quickly as global markets settle down and rally, but is still down 43.08% since August 03. The October VIX has lost 20.90% since September 01, yet is still up 28.66% from August 01. Unfortunately, one cannot simply device a model or formula to determine the profit (or loss) potential when the VIX rallies or sells off versus the performance of the XIV. The best we can do is state a 1.24-1.50% correlation between the two. In other words when the VIX rallies an investor should loss approximately $1.25 for every dollar in XIV and when it falls gain approximately $1.50. This is not an exact mathematical formula but simply based upon our own correlation analysis. There are simply too many variables that influence the price action for this correlation to be valid over a significant period of time and further analysis is necessary. Investors should also be aware that the ETN has a net expense ratio of 1.35% versus a category average of 1.27%. In addition, the beta of the ETN is -.90 and the Alpha is -1.7 for the past three years. This is obviously almost a total negative correlation to the S&P 500, but not 100% or a perfect -1.00. A recent article in Barrons stated traders have shunned the ETN this month. Investors placed $345.00M in the ETN in late August, while have only put in $18.9M since September 03. The ETN presently has 1.48BLN market capitalization. The Barrons’ writer should have analyzed further why this is so. One way is to review the holdings of the ETN. Yes, many trader’s use this vehicle as a speculative tool. Predominately, there are large funds and institutions that have placed substantial funds in the ETN as a hedge vehicle for their pension and other large institutional investors. For example, Lazard Capital has a particular fondness or appetite for the vehicle, owning 72,250 shares or 1.76% in one of their Institutional Funds. In addition, Credit Suisse (NYSE: CS ) holds a 26.453% stake, UBS (NYSE: UBS ) 6.46%, and Citigroup (NYSE: C ) holds 3.42%, among other firms. Overall, institutions own approximately 74.04%, with mutual funds hold only .49%, according to Fidelity.com. As such, these institutions are not so much traders as they are hedgers. These investors are simply holding at this time and not adding to their position or selling. They have already placed their hedge for the next quarter. As such, they are using it as a vehicle for their overall holdings to take advantage of lower volatility and add “alpha,” without having to directly go to the futures market. In addition, there are many hedge funds that are using the vehicle to take advantage of a decline in volatility going forward. As a retail investor we feel that an investor may participate with the institutions but only with a portion of assets and on a strictly month to month basis. This is our primary reason in analyzed this ETF since August 01. Since the beginning of the year XIV is down 12.05%, but -44.61% since June 24 when it hit a price of $50.10. It is fruitless as a retail investor to use this ETN as a long term investment vehicle. A quarter to quarter investment or hedging tool to take advantage of calming markets and lower volatility is fine. Unfortunately, we would not recommend this vehicle as a long term, let alone cyclical type investment vehicle. The risks are simply too high as a buy and hold investment. Take advantage of the higher volatility, pick up a quick return of possibly 10% riding the wave of lower volatility, but don’t overstay the party. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. Additional disclosure: Additional information and analysis is from velocitysharesetns.com, morningstar.com, fidelity.com, yahoofinance.com, tdameritrade.ca, cboe.com, and our own analysis.