What Patent Cliff? Pharma ETFs Continue to Surge


"Many analysts discounted pharma's ability to plan for the 'patent cliff.' The industry has been hard at work building up cash reserves in order to boost nearly empty pipelines."

For at least the past few years, investors in the health care segment have been focused in on big pharma and the segment's fast approaching 'patent cliff.' During this period, many of the industry's most popular and best selling drugs go off patent and will face heavy generic competition, slashing profits for many members of this group.

To top things off, there is little in terms of new drugs to replaces these blockbusters, suggesting that once companies go past this cliff they will have significant trouble coming back. In fact, according to The Economist, blockbusters with a combined $170 billion in annual sales will go off-patent by 2015, creating a life-threatening situation for many of the top companies in this sector.

Given this bearish outlook, many analysts and bloggers, including myself, assumed that the pharmaceutical sector would be in for a world of pain leading up to and immediately following this cliff. However, the sector has proven to be incredibly resilient over the past few years and has, shockingly, outperformed many other segments of the health care industry and even the broad economy over the past few years.

Instead of slumping, the pharma ETFs have been among the top performers in the equity exchange-traded fund world over the past few years. In fact, of the three pharmaceutical focused ETFs that have been around since 2009, all of them have at least doubled in the past three year period (also read The Five Best ETFs over the Past Five Years).

This incredible performance puts these products into elite company in terms of equity ETF investments that are focused on the U.S. market. Just 15 products have doubled in this time frame while the S&P 500 added about 53% in the same period, demonstrating just how well pharmaceutical stocks have done despite the headwinds facing the industry.

How They Did It

Seemingly, many analysts heavily discounted pharma's foresight and ability to plan for this upcoming issue. The industry has been hard at work building up cash reserves and deploying them on small biotech/pharma firms in order to boost nearly empty pipelines.

Already, firms in the space are finding targets in the mid cap segment, scooping them up in order to obtain access to their more impressive drug lineups, potentially taking some of the pressure off of big pharma for the time being.

It also appears as though drug companies have become much shrewder about how they fight generic competition. In an Economist article, it is revealed that Pfizer worked with an American firm in order to help break apart a 180 day generic exclusivity period, helping the company compete with often times cheaper generics.

The company also seems to be partnering with big health care providers in order to give them cheaper drugs, thereby at least getting some inflows based on sheer volume. The article also claims that these practices have helped to boost sales by over half a billion in the first half of 2012, taking at least some of the pain of the patent expiration out of the equation.

Lastly, the recently passed, although still controversial, Obamacare bill could also help big pharma in the years ahead. Should millions of Americans be forced to get insurance and thereby have access to drugs, it could open up a whole new market for these firms that was out of reach until now, potentially boosting sales in the process (read Health Care ETFs in Focus on Obamacare Supreme Court Decision).

Clearly, pharmaceutical stocks have managed to take some of the points above to help dispel at least a few of the worries that investors have about the segment's massive patent cliff. Should this continue, pharma could remain an intriguing choice for investors, especially if dividends remain high and if the sector can act as a safe haven for those concerned about the health of the global economy.

Eric Dutram
Zacks Investment Research

Get Our Streetwise Reports Newsletter Free

A valid email address is required to subscribe