Your Money: Opt for mid-caps in defensive sector

Large-cap companies in pharma and IT sectors are facing growth slowdown

Once darlings of investors who wanted at stable returns, the pharmaceuticals and information technology (IT) companies have been among the worst performers this year. For the first time in the past five years that these defensives have negative returns.

The S&P BSE Healthcare has negative returns of 12 per cent since the beginning of the calendar year and the S&P IT is down 9 per cent. But whenever these sectors did not perform well in any year; they turned around aggressively. In 2011, BSE Healthcare and BSE IT indices had negative returns of 14 per cent and 18 per cent respectively. But in the following years, they made up for it.

Fund managers, however, believe that this may not be repeated. “Defensives are no longer what they used to be. Investors need to be cautious when picking stocks in the two sectors as the outlook for them remains bleak in the near term. They should focus on smaller companies (mid-caps) that would be able to tide the changing business environment,” says G Chokkalingam, Founder of Equinomics Research and Advisory. He points out that returns from fast moving consumer goods or FMCG companies have fallen. The BSE FMCG index is down one per cent since the beginning of the year. IT companies are witnessing a slowdown in their growth. “This year, their growth was 8-9 per cent in dollar terms compared to 12-15 per cent three years back,” says Jinesh Gopani, head of equities, Axis Mutual Fund. He explains: there has been pricing pressure in the developed countries. While there has been volume growth, the value growth has not happened. Unless economies in the developed countries recover, the growth of larger companies are expected to remain under pressure. If you invest in equities directly, fund managers say that they prefer smaller peers of the bellwethers, who have been able to buck the trend as they are strong in the respective niche segments. Investment managers expect consolidation which will benefit investors.

The bigger pharma companies are hit by the regulatory hurdles. The U S Food and Drug Administration has been raising red flags at manufacturing plants of many big drug exporters. “We are betting companies that have diversified their manufacturing facilities and also the management is capable to comply with the regulatory norms,” says Nilesh Shetty, associate fund manager-equity at Quantum Asset Management. Chokkalingam say he prefers smaller companies that either have significant business in India or are not hit by the regulatory problems as they are into different segment such as contract research and manufacturing.

Blip or long-term pain?

Sonam Udasi, Fund manager at Tata Mutual Fund says that those who already hold large-cap stocks in their portfolio in the two sectors, it’s time that they relook at their investments. Those who have invested using mutual funds, can relax. While the funds have given negative returns at par with the respective indices, things are expected to improve by the end of next quarter. “Many fund managers in sectoral funds are deliberately sitting on large cap companies, as they are easy to liquidate in any market condition. Once there a clearer picture on the companies’ financials after the next quarter, they will move forward with their investment strategy,” says a fund manager.