Pharma sector back in focus; outlook positive but bets likely to be risky

As the outlook for pharmaceutical companies improve, returns from mutual funds representing the sector have outperformed all equity schemes in the recent past. The average three-month return of pharma funds is 13.48 per cent. All other equity schemes have single-digit returns except technology funds (10.33 per cent) in the same period.

The same holds true for one-month returns. Average returns of pharma funds are at 8.59 per cent. Average gains of other equity schemes are below one per cent except for technology funds, which are at 4.42 per cent. Pharma sector had faced many challenges between 2015 and 2017. There were regulatory issues for companies focussed on international markets and also there was an impact from emerging market currency depreciation. But for one year, things have started improving.

Regulatory issues have started settling down, and a depreciating rupee has also provided a tailwind to the performance of these funds. “Until last year we focussed only on the domestic companies whose valuations were 30-40 per cent cheaper to the other consumer-driven sectors. We included companies that are leaders in their domains, and it paid. When pharma companies focussed on the US started correcting, we again went for the leaders,” says Shailesh Raj Bhan, deputy CIO, equity investments, Reliance Mutual Fund. Bhan is also the fund manager for the Reliance Pharma Fund, which is the best performing pharma fund with 27.96 per cent returns in the past year.

Things are further improving for companies focussed on the US. Many large generic US players are moving out of certain drugs, which creates opportunities for the Indian players. “Many pharma companies have also diversified to various other geographies such as the UK, Russia, Africa, and so on. They have tried to reduce their dependence on the US market, even though it remains the most lucrative market,” says Danesh Mistry, fund manager, Tata Mutual Fund. Due to all these factors, the earnings visibility for these players has improved.
 

As for the domestic-focused players, the market has decided to re-value them. “Many of them have branded drugs. In recent times, the market has re-rated these as it feels that these brands have strong and sustainable equity in the Indian market,” says Mistry.

While the regulator risks exist for the US-focussed players, fund managers say that the sector will continue to perform well. “The valuations of the pharma companies are not high yet. They are in line with the broader markets. We may see earnings recovery driven by currency weakness, stabilising US market and growing domestic market,” says Bhan.

Pharma sector funds have outperformed diversified equity schemes even over the long-term giving annualised 17.86 per cent returns over the past decade. Despite the long-term track record, mutual fund analysts suggest that if retail investors want to take exposure to these funds, they should only do it through an advisor. “The entry and exit into these funds need to be timed — not an easy task for a retail investor with limited resources. Unless there’s professional guidance, small investors can avoid taking exposure to pharma sector schemes or for that matter any sectoral funds. Even if they do, they should restrict it to five per cent of the equity portfolio,” says Kaustubh Belapurkar, director, fund research, Morningstar Investment Adviser India.

Most sector funds form a small part of the economy, and they also carry a high concentration risk. The only sector fund that has a larger contribution to the economy is banking. “Banking is also broad-based with public sector banks, private banks and non-banking finance companies and domestically driven,” says Belapurkar.