ETFs That Target Disease

New baskets of stocks let investors bet on breakthroughs

Are you an aging baby boomer suffering from heartburn, overactive bladder, or sexual dysfunction? Imagine being able to invest in a basket of small companies developing cutting-edge treatments for these disorders. A new set of exchange-traded funds (ETFs) will allow investors to funnel dollars into specific disease categories, including cancer, eye maladies, and yes, gastrointestinal and gender-specific disorders. The funds will start trading on the New York Stock Exchange (NYX ) in weeks, pending a green light from the Securities & Exchange Commission.

The new family of funds, called HealthShares and developed by Ferghana Wellspring in New York, is the latest twist in the red-hot world of ETFs, which are similar to index funds but can be traded like stocks. So far this year, 124 new ETFs have launched, more than double the number started in all of 2005, according to Morningstar Inc. (MORN ). Upwards of $5 billion in new assets flowed into ETFs in the second week of October alone, and about 10% of that went into sector-specific funds, reports Bank of America Corp. (BAC ). Nineteen ETFs are health-related, but none is focused narrowly on therapeutic categories like HealthShares.

Why invest in diabetes (via the metabolic-endocrine disorders ETF) or finding new remedies for baldness (that would be the dermatology and wound-care ETF)? Some investment theorists would answer that the best way to generate low-risk returns is to own a piece of every asset class available, and these ETFs create a new class: diseases.

Ferghana Managing Director William J. Kridel Jr. argues that HealthShares can get investors in early on up-and-coming biotechs -- unlike broader funds that may be overweighted with slow-growth companies. The upper limit on the market capitalizations of HealthShares companies will range from $10 billion to $20 billion, depending on the fund. That knocks out most Big Pharma companies and major biotechs. "You don't need us if you want [to invest in] Pfizer (PFE ), Johnson & Johnson (JNJ ), and Amgen (AMGN )," says Kridel. "We're exposing investors to the part of the market where there's growth and innovation."

Certainly, the new ETFs offer some creative possibilities. An investor who's bullish on cancer cures but pessimistic about a particular company working on them could buy an oncology ETF while simultaneously selling that company's individual stock short -- a bet its shares will fall. Conversely, someone who thinks the market for oncology companies has gotten too frothy could short the cancer ETF and choose instead to go long on cardio or ophthalmology ETFs.

The downside: The ETFs may be too risky to dabble in without a professional adviser on hand. Some ETF analysts say investors eager to advance cures and also do well in the market might be better off donating some of their savings to research foundations and investing the rest in something safer than biotech. Each HealthShares basket will contain shares of 22 to 25 companies, any of which could blow up at the first sign of a failed clinical trial. "You could be right about the theme, but end up with a portfolio that doesn't include the biggest winner," warns Thomas McManus, chief investment strategist for Bank of America (BAC ). "Or you won't have enough winners to offset losses."

Kridel believes foundations may find HealthShares appealing. Yet that notion seems unlikely to Greg Simon, president of FasterCures, a Washington (D.C.)-based arm of the Milken Institute seeking to speed up scientific research. "A couple of [disease research] foundations might decide it's symbolically important" to invest, he says. But the financial types managing the endowments could knock down such notions. "Bankers won't be starry-eyed."

By Arlene Weintraub

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