GNOM: Poor Historical Performance & Uncertain Future (NASDAQ:GNOM)

Global X Genomics & Biotechnology ETF (NASDAQ:GNOM) is a healthcare exchange traded fund (ETF) launched and managed by Global X Management Company LLC. It invests in public equity of long term growth-oriented companies that are part of the ‘Genomics Revolution’, primarily in the US market. It benchmarks the performance of its portfolio against the Solactive Genomics Index. The fund is currently trading 13% over its 52-week low and has $178.68 million of Asset Under Management (AUM).

Global X Genomics & Biotechnology ETF is a relatively new ETF, launched almost three years ago. With an expense ratio of 0.5%, this ETF is relatively inexpensive. This ETF is not meant for income seeking investors as it intends to pay semi-annual dividends, but has been able to pay dividends on only two occasions, that also with a negligible yield. Thus, the investment decision will solely depend upon the expected future performance of the fund over the long run. In order to understand the future growth potential of this ‘Genomics Revolution’ based ETF, we need to understand the growth prospect of ‘Genomics Revolution’, the historical performance of the fund, and the potential of the constituent stocks to produce significant returns.

As of March 25, 2022, GNOM’s top 89% of its holdings are in companies engaged in biotechnology and Life sciences tools and services. A significant resource of these companies goes to genomic research. These companies are engaged in scientific research that aims to “enhance the quality of human and other life by incorporating technological and scientific developments, improvements and advancements in genomics into their business, such as by offering new products or services that rely on genomic sequencing, analysis, synthesis or instrumentation… These companies may also develop, produce, manufacture or significantly rely on or enable bionic devices, bio-inspired computing, bioinformatics, molecular medicine and agricultural biotechnology.”

Global X Genomics & Biotechnology ETF has historically performed very poorly. GNOM has recorded a negative growth of around 37.5%, 34%, and 3% over the past six months, one year, and five years, respectively. We all know that the biotechnology sector had an extremely poor 2021. Still, for an ETF to generate negative return over the past three years is unusual. There are other genomic revolution funds like Invesco Dynamic Biotechnology & Genome Portfolio ETF (PBE), iShares Genomics Immunology and Healthcare ETF (IDNA) and ARK Genomic Revolution ETF (ARKG), which also performed poorly last year, but had generated strong growth over the past three years.

Despite the market price falling by 50% in the past one year, ARKG registered a growth of 42% over the past three years. PBE‘s price also fell by 17.6% in the past one year, but grew by 13.3% over the past three years. For IDNA, the price drop of 26% over the past year was compensated by a 38% growth over the past three years. During the same period S&P500 grew by 16% and 68% respectively. I further tracked down the performances of three other biotechnology ETFs, outside the purview of ‘Genomic Revolution’ – First Trust NYSE Arca Biotechnology Index Fund (FBT), SPDR S&P Biotech ETF (XBI), and ProShares Ultra Nasdaq Biotechnology (BIB).

I find that over the same time horizon (three years), BIB generated 16.4% growth despite a 29% downfall during the past year. Though quite low, FBT and XBI, too, generated positive growth over the past three years despite suffering significant losses during the past year. Needless to say that GNOM did not perform well enough to compensate for the loss it incurred in the past one year. The stocks included in this ETF are not volatile enough, rather they have a tendency to generate below average growth when the sector is bullish, and fall drastically when the market is bearish.

On further analysis, I found that out of its top 25 holdings, only four stocks – Genscript Biotech Corp (OTCPK:GNNSF), BioNTech SE (BNTX), Alnylam Pharmaceutical Inc. (ALNY), and Vertex Pharmaceuticals Inc.(VRTX) – have recorded a growth over 10% during the past year. Four other stocks -Agilent Technologies Inc (A), Intellia Therapeutics, Inc. (NTLA), BioMarin Pharmaceutical Inc. (BMRN), and Sarepta Therapeutics, Inc. (SRPT) – have been able to generate positive growth. 17 other stocks have incurred losses, with the price of as many as eight stocks dropping by at least 50%. These eight stocks were Veracyte Inc (VCYT), CRISPR Therapeutics AG (CRSP), NanoString Technologies Inc (NSTG), Editas Medicine Inc (EDIT), Natera Inc. (NTRA), Pacific Biosciences of California Inc (PACB), Regenxbio Inc (RGNX), and Rocket Pharmaceuticals Inc (RCKT).

A basic investment philosophy followed by many theme based funds emphasizing on technological revolution is to invest in higher alpha-producing entities, and once such stocks deliver supernormal growth, replace them with established large-cap entities. Alpha producing stocks produce excess returns over the average return of similar types of stocks or over any benchmark index. In a diversified portfolio, alpha producing stocks help to generate higher returns, but at the same time have higher risks. As GNOM seeks to invest in long term growth oriented companies that are part of ‘Genomics Revolution’, it should have sold off a few of its gene-editing and sequencing pioneers like EDIT, PACB, RCKT, and CRSP, once they generated a strong growth, and should have replaced them with less risky large-cap biotechnology stocks.

CRSP, a gene-editing company, focuses on developing transformative gene-based medicines for serious human diseases. EDIT, a clinical stage genome editing company, focuses on developing transformative genomic medicines to treat a range of serious diseases. While RCKT focuses on developing gene therapies for rare and devastating diseases; PACB designs, develops, and manufactures sequencing systems to resolve genetically complex problems. All such stocks betting on technological revolution have a tendency of suffering huge losses once they become highly sought after, as the lack of current earnings and cash flow make such stocks seemingly overvalued. These four stocks also recorded extraordinary growth in the beginning of 2021, and then fell by 50% or more over the past one year.

A case in hand can be its peer, ARKG. ARKG has been very successful in betting on some promising innovations in genomics. “Shares of gene-editing pioneers Editas and CRISPR skyrocketed more than 100%, pacing the gains in ARKG”. However, ARKG sold its stake in both these stocks before July 2021, and again brought back CRSP under its portfolio as soon as it lost significant value. Interestingly, till early February 2021, GNOM was growing at sync with S&P500. But, in absence of timely reshuffling of its portfolio, this genomic revolution based ETF has failed to keep up.

Going forward, GNOM may try to adopt this investment philosophy. However, I don’t see such an opportunity in the near future. All the eight stocks (barring NTLA) delivering positive growth in the past one year, are either large-cap biotechnology/life sciences firms or are not focussed on gene-editing and sequencing. The only exception, NTLA, which is a genome editing company and is focused on the development of therapeutics, has a very low growth rate of 7.7%. Thus, in my opinion, this ETF will have a tough time ahead, and investors may have to wait for an extremely long period to see some strong and steady growth.

Weighted average Price to Equity ratio of the component stocks of GNOM comes to around 18.51, compared to the index’s Price to Equity ratio of 15.88. This suggests that the ETF is slightly overvalued and there is still scope for a downward rally of this fund. This assumption gets further validation as all the long-term moving averages of this fund are above the short-term moving averages. Thus, there lies every possibility of stiff downward movement with every downward trend in the market. Moreover, being a theme based biotechnology index fund, it cannot overcome its inherent volatility and market risk, which may arise due to changes in investors sentiment or any negative news about its constituent stocks or the sector as a whole. However, a course correction is very much possible too, if the biotechnology sector gets some positive boost or gets into any bull run. At present, that seems very unlikely.

In my opinion, GNOM is neither suitable for income seeking investors, nor for long term investors. Though the fund is well diversified within large, mid, and small cap biotechnology firms, GNOM failed to generate returns. The fund claims to select Genomic revolution as its theme. However, it fails to focus only on such companies, and invests across the biotechnology sector. Genomic revolution for sure has good growth prospects. But, I don’t think GNOM will be able to capitalize on it due to its lack of focus.

This portfolio, in my opinion, may only generate strong and steady returns, when the entire biotechnology sector will be booming. There are also possibilities of strong and steady growth in case there are sudden incentives to gene-editing and sequencing research and related activities. Another very important thing to note about GNOM is, investors can’t hedge their exposure by buying or selling calls and put options for a duration of six months or longer. Some options are available for August 2022, but November 18, 2022, options are still not available. In my opinion, there are much better genomic revolution based ETF such as ARKG and IDNA; and other biotechnology ETFs, such as BIB; available in the market.