As inflation takes centre stage in economic discussion across central banks and investors, the time may be ripe to increase allocations in defensive sectors such as pharmaceuticals. One passive way to actively play the sector is an allocation to sector funds investing in pharma. As the sector addresses the issues of the last few years for better growth prospects, a broad and active stock investing may deliver better risk adjusted returns. Of the three sectoral funds with more than seven years of track record, Nippon India Pharma Fund has an edge over peers in limiting losses and capturing peaks.

Pharma risks priced in

Following the post-Covid rally led by Indian pharma, the stocks hit their peaks in late 2021 followed by a correction since then and are now trading in the average range of the last 7 years. Pharma stocks were in focus at the beginning of the pandemic owing to long period of underperformance starting from 2015 and playing a central role in pandemic recovery. As one-time Covid sales begin to taper off and the central risks including product and plant related regulations began making the rounds at company announcements, stocks valuations also shed their earlier exuberance. All the while the companies have recalibrated their approach to growth, taking the risks on hand into consideration. While no one product or geographic strategy can ensure high growth, this makes broad investing one of the safer approaches to the sector.

Performance

Nippon India Phama Fund managed to barely match its benchmark (S&P BSE Healthcare) in period 2011-2016, when pharma stocks pursued big opportunities made available through US patent cliff, returning 23.8 per cent CAGR for the period (benchmark 24.3 per cent). Nippon outperformed the index in the following, consolidation phase of 2016-2019 (-0.9 per cent CAGR Vs. benchmarks -6.4 per cent) and in the more recent period which included the post-Covid rally (2019-2022) returning 31.9 per cent CAGR Vs. benchmarks 26.9 per cent.

Nippon India Pharma fund limited its losses and extended gains by investing in MNC’s and companies scaling their US portfolio in the consolidation phase and later by including hospitals, labs and API players in the portfolio.

Prospects

Investing in large-cap and mid-cap, pharma, hospitals, and healthcare related stocks the fund pursues outperformance through relative weighting, across sectors and companies within sectors. The top position by weight as on January-2022 is Sun Pharma with 12.4 per cent weight, which is the highest the fund held in Sun Pharma in recent years. This may reflect the optimism in Sun’s speciality differentiated portfolio which is unaffected by US generics pricing commentary to a large extent. Cipla and Divi’s Laboratories figure in the top five as well with exposure to developed market respiratory portfolio and API custom synthesis opportunities, respectively. Dr. Reddy’s and Lupin in the top 5 weights and Aurobindo Pharma and Torrent Pharma in the top 10, are stocks which have been impacted by lower margins, US pricing pressure and slower launches which is also reflected in strong price correction for the four in the last 2 months.

Over the years Indian domestic pharmaceutical market has delivered strong growth as penetration increased and the fund gains exposure from the same set of stocks mentioned, who have a strong domestic presence as well. Even, Aurobindo Pharma seems to be eyeing the market within next three years.

The fund has invested close to 22 per cent as on January-2022 in hospitals and diagnostics companies. These companies are expected to benefit from the increasing penetration of healthcare services over a long term but are currently at higher valuation since the pandemic. Compared to earlier part of the decade the fund seems to be investing a lower proportion in MNC’s firms, but which still accounts for 9 per cent, which implies a higher growth potential for domestic firms.

As companies work-around lower growth in US markets and pursue different niches to counter the same, the fund can offer diversified growth potential in healthcare. The recent corrections in Pharma and upcoming concerns around inflation also support the case for investments in defensive sectors.

Do note that sector funds carry high risk as diversification is limited and sector itself can deliver negative returns over several years and investments must be made as part of overall portfolio allocation strategy and enter at the right time.

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