Biotech Shredding

Today's action in the biotech sector teaches, and validates, all sort of things to people that invest for themselves.

Elan (ELN) and Biogen Idec (BIIB) pulled their drug Tysabri because of side effects that caused a fatality. ELN is down by 68% and BIIB is down by 46% as a result. The other day I wrote about picking stocks like Anheuser Busch not being that difficult but that trying to game an FDA approval is a different story. Today makes the point for me. The story behind this drug sounded great from the start, but most of the stories do. Both stocks have had a major lift because the Tysabri story was so exciting. Clearly the news came out of nowhere. I think that if there was any visibility to this happening neither stock would be down this much.

I have exposure to BIIB for some clients through the iShares Nasdaq Biotech Fund (IBB). BIIB has about a 6% weight in the fund but I'm not sure if the iShares site has adjusted that info for today's move or not. Other clients have exposure to a biotech stock that is not impacted by today's story.

The Irish Stock exchange is also feeling some pain down more than 5% due to Elan's weighting, but interestingly the financial sector in Ireland is up today.

I think it makes sense to explore what impact owning either of these stocks in a properly diversified portfolio would be. In the accounts I manage the largest weight a biotech stock would have is 2%. If I had a 2% weight in Elan today's drop would account for a 1.36% hit to the portfolio. I might get called out on the carpet by clients for the pick but this is not the type of blow that causes financial damage to someone's way of life. This is constructive as to why I have 40 or so stocks in an account. No one saw this coming. The next time some company commits ruinous fraud there will be very few people that will see that coming. Some things no amount of research can prevent. Diversification insulates a portfolio from the un-researchable.

A last point is about the Biotech HOLDRs (BBH). It had what I surmise was a 14% weight in BIIB before the news today. I wrote about this for ETFzone many months ago that the concentration in a lot of the HOLDRs makes them riskier than corresponding iShares. Today proves the point. BBH is down about 7% and IBB is down about 4%.

On another note this site was picked as a site of the week over at ThinkingBull.com. Thanks for the nod.