ICICI Prudential has launched a pharma index fund, ICICI Prudential Nifty Pharma Index fund, which will replicate the Nifty Pharma index. The index itself includes the top 20 stocks (by free float market capitalisation) operating in pharmaceutical sector. The index is rebalanced every six months. So, no stock accounts for more than 33 per cent and no three stocks take up more than 62 per cent of the index at the time of rebalancing. The NFO will be open till December 09.

BSE Healthcare and Nifty Healthcare are the other two benchmarks , but essentially all three indices are primarily influenced by pharma companies’ performance, supplemented by hospitals and diagnostics labs .

Specific to pharma, passive investing may dampen return potential. Among the five active pharma funds with more than four-year history , there have been only five instances from 20 data points that Nifty Pharma has beaten the active funds (see table).

We evaluate the active investing case in pharma funds over passive investing.

Fund focus

With a product portfolio spanning different therapeutic focus, geographic presence, presence across innovation value chain, tactical allocation assumes a higher importance in pharma sector.

There is a generics vs branded generics trade-off, speciality or complex products trade-off, CDMO/API or formulations trade-off. In the current climate, for instance, speciality led by Sun Pharma, respiratory led by Cipla and complex portfolio led by Natco and Dr. Reddy’s are placed better in the sector. In the past two years, it would have been Covid products led by Glenmark and Cipla, volume play at Aurobindo Pharma and Lupin, and API/CDMO focussed Divi’s, Granules and Laurus Labs that were in investor focus. A passive fund following free-float market capitalisation would be glacial in reflecting market preferences and most likely reflect the changes in allocation following correction/appreciation of stocks.

Geographic composition of sales across companies also has a significant bearing on stock returns, which needs tactical alertness to leverage. In the current scenario, US pricing pressure may be showing signs of easing after having re-emerged post-Covid. This may or may not lead to a strong support to US heavy companies. Nevertheless, domestic-heavy operators are gaining favour in the current context. But domestic preference has not benefited MNC pharmaceuticals (who focus entirely on domestic formulations) and have returned lower than Nifty Pharma in the last one year (except for Abbott India), as domestic focus gains amongst Indian players.

Beyond product and geography, there is regulatory play for the pharma equity manager to leverage in the segment. Pharma faces high regulation on plant and product from multiple institutions. Based on facility standards improvement drive by US-FDA or impurities-related recalls, timelines of complex product approvals, pharma managers must take positional calls, however risky the call may be. The legal aspect in product approvals, for instance generic Revlimid approval and anti-trust litigation currently underway, are also opportunities where tactical positioning can be advantageous.

Nippon India Pharma has a better track-record among active funds and has resorted to allocation changes that produced such results. Nippon Pharma beat Nifty Pharma index substantially in 2016-17 following pharma meltdown on account of US price-erosion. This was achieved by investing in domestic-focused MNC companies in the period against US-focused companies that dominated the pharma index. In the Covid period, active funds including Nippon India increased allocation to API and Covid product manufacturers, which further allowed them to cement their outperformance versus the index.

Rolling returns

On a rolling returns basis, which indicates performance over a given time-period since inception on a daily basis, Nifty Pharma has come close to the broader index returns only on a 10-year holding period. Over a year, holding Nifty Pharma index has been disadvantageous compared to Nifty 50. But over the period and in any time-frame, Nippon India — an active fund, has managed to better both indices. The pharma sector, when compared with Nifty 50 which is at a high point, may be positioned better. The ‘defensive’ tag, focus on high-growth domestic and EM markets, and bottoming US franchise, offers strong growth prospects. An active play on the sector will add higher risk-return lever to investors over passive index investing.

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