Current ecosystem favours pharma mutual funds

Earlier I’ve used this space to disseminate information on how an investor could benefit from investing in pharma based or themed mutual funds (MF). The current macro environment has been favoring this sector, first the improvement of pharmaceutical processes that suit the US FDA (United States Food & Drug Administration), the overall growth in the sector both domestic & international and rupee depreciation.

The FDA observations on various facilities of major drug manufacturers in India a few years back has led to the re-rating of their stock valuations. Now, as the tide turns, improved compliance on these parameters has set the clock right.

The pharma index has largely outperformed most of the other indices (except IT) and even broader market in the last one year. The categorisation of MF by Securities and Exchange Board of India (SEBI) has resulted in not just rationalisation of funds across the asset management companies but also allowed them to launch funds to address the opportunities available in the market.

The pioneer in this category is by Reliance through their offering of Pharma fund which was launched way back in 2004. Then the space has come up with more solutions and innovations in this space.

The other funds are UTI Healthcare fund, Tata India Pharma & Healthcare fund, SBI Healthcare Opportunities fund and ICICI Pru Pharma Healthcare and Diagnostics (PHD) fund.

Each brought a bit of ingenuity at looking at the investment philosophy to bring a different flair and exposure to managing the money in this segment. The latest offering in this segment is the new look DSP after the takeover of Blackrock’s stake through DSP Healthcare Fund.

To bring in a bit of different style to explore this segment, the fund house approached at an inverted structure when compared to the existing offering in the market. The capitalisation of existing funds (due to their timing and existence) have remained mostly large-cap skewed with presence in other caps at relatively lower proportion.

While DSP has taken a contra approach by exploring small and mid-cap domination with relatively lower allocation towards the large cap. The rationale is the recent corrections in mid and small caps now look attractive in this segment. Of course, the fund is capitalisation agnostic and could later change allocations depending upon the market opportunities.

The major differentiator is the presence of foreign securities related to healthcare i.e. mostly to with the medical devices’ manufacturers etc, based out of the US. The argument here is that Dow Jones Healthcare index is growing at a healthy 19 per cent on an average annually for about a decade which is similar to what we experience in the BSE healthcare index but with much lower volatility.

The non-correlation is thus attractive and is good diversification strategy. Moreover, there is nil or minimal competition in this segment of the business from India or China which are delivering a decent 15 per cent – 20 per cent returns annually. This is limited to a maximum of 25 per cent of the fund and any higher allocation would change the tax treatment of this fund from being a domestic equity fund.

The tentative portfolio allocation would be as follows -- the US healthcare up to 25 per cent, export focused pharma companies compose about 10-20 per cent, evolving generic companies add to 10-20 per cent, domestic focused companies comprise about 30-40 per cent, contract research and manufacturing proportion to 5-15 per cent and up to 10 per cent is allocated in each of the segments of diagnostic laboratories, hospitals and health insurance companies.

This way they could achieve the desired diversification and also expose across the market caps. This makes the fund to have higher exposure to healthcare segment than their peer group. The other generic factor which could be an optional for the entire growth of the sector is the launch of “Ayushman Bharat” by the central government which would benefit about 50cr individuals to utilise better healthcare facilities.

This could benefit the listed players in hospitals and health insurance companies in the medium to long run. However, the highlight of the fund is in the management team which has a collective experience of 34 years directly in pharma industry and equity research of pharma industry.

The current market conditions and risk profile of this fund dictate investors to go for NFO investment with staggered top-up for a minimum of three-year horizon or more to get the best out of this fund.

Please do note that it being a thematic or sectorial fund is relatively of higher risk and doesn’t suit for all kinds of investors. An ideal allocation of 5-7 per cent would add flavour to their portfolios in the medium-term horizon. (The author is co-founder of “Wealocity”, a wealth management firm and could be reached at [email protected])