It has been a tough four months for biotech investors since the indices hit all-time highs in early July. The sector then staged a substantial pullback that moved it into official bear market territory before the main biotech indices hit a bottom in late September. Since then a definite pattern has emerged as the sector has split; small developmental concerns continue to be pummeled by investors while the larger cap companies have regained ground.

The New Pecking Order

There has been a pecking order within the biotech sector that has emerged during the recent bout of volatility throughout the space. Large cap growth stocks that make up what I like to call “core” positions have a solid grip at the top of that pecking order. This is not unexpected as this happens pretty much every time sentiment turns negative on the sector. This almost always triggers a “flight to quality”. These “core” positions have real revenue and earnings growth, reasonable valuations, solid balance sheets and developing pipelines. They often pay nice dividend yields as well. Good examples of this sort of holding are Amgen (NASDAQ: AMGN) which just raised its dividend 27% last week. Other good large cap growth positions in the sector include Gilead Sciences (NASDAQ: GILD) and AbbVie (NASDAQ: ABBV)

This is why I have always emphasized that 50% to 75% of an investor’s overall biotech holdings should be in these types of core positions, depending on individual risk preferences. This is one of the key principles both within my own portfolio and that of the portfolio for Biotech Gems. This philosophy has been a key driver of performance in 2015. It has also allowed me to navigate this recent bout of volatility within biotech while minimizing risk.

Next up in the current hierarchy within the biotech space are small cap concerns that have commercialized products and actual revenue and earnings streams. A good example of this is a small biopharma called ANI Pharmaceuticals (NASDAQ: ANIP) whose recent bottom coincided almost perfectly with the overall bear market bottom for biotech that occurred near the end of September. The stock has slowly started grinding up since that time. Horizon Pharma (NASDAQ: HZNP) is another small cap biopharma in the same situation. Both are cheap given their growth prospects and appear to be doing better now that Valeant Pharmaceuticals (NYSE: VRX) much-publicized troubles appear to be lifting a bit.