With inflation taking center stage in economic discussions between central banks and investors, now may be the time to increase allocations in defensive sectors such as pharmaceuticals. A passive way to actively play the sector is an allocation to sector funds investing in the pharmaceutical industry. As the sector tackles the problems of the last few years for better growth prospects, broad and active equity investment can offer better risk-adjusted returns. Among the three sector funds with more than seven years of experience, Nippon India Pharma Fund has an edge over its peers in limiting losses and capturing peaks.
Pharmaceutical risks taken into account
Following the post-Covid rally led by Indian pharma, stocks hit their highs in late 2021 followed by a correction since then and are now trading in the average range of the last 7 years. Pharmaceutical stocks were in focus at the start of the pandemic due to a long period of underperformance starting in 2015 and playing a pivotal role in the recovery from the pandemic. As Covid one-off sales begin to wane and core risks, including product and plant regulations, begin to make the rounds in corporate announcements, stock valuations have also lost their former exuberance. Meanwhile, companies have recalibrated their approach to growth, taking into account the risks involved. While no product or geographic strategy can guarantee high growth, it does make investing at scale one of the safest approaches in the industry.
The Nippon India Phama Fund managed to barely match its benchmark (S&P BSE Healthcare) during the 2011-2016 period, when pharmaceutical stocks pursued great opportunities offered by the US patent cliff, posting a CAGR of 23.8% for the period (benchmark 24.3%). Nippon outperformed the index in the subsequent consolidation phase of 2016-2019 (-0.9% CAGR vs benchmarks -6.4%) and in the more recent period which included the post-Covid rally (2019-2022 ) returning 31.9% CAGR Vs. benchmarks 26.9 percent.
The Nippon India Pharma fund limited its losses and extended its gains by investing in multinationals and companies that expanded their US portfolio in the consolidation phase and later by including hospitals, laboratories and API players in the portfolio.
Investing in large and mid-cap, pharmaceutical, hospital and healthcare-related stocks, the fund aims to outperform through relative weighting, across sectors and in companies within sectors. The top position by weight in January 2022 is Sun Pharma with 12.4% weight, which is the highest the fund has held in Sun Pharma in recent years. This may reflect optimism in Sun’s differentiated specialty portfolio that is largely unaffected by comments on US generic pricing. Cipla and Divi’s Laboratories are also in the top five with exposure to the developed market respiratory portfolio and custom API synthesis opportunities, respectively. Dr. Reddy’s and Lupine in the top 5 weightings and Aurobindo Pharma and Torrent Pharma in the top 10, are stocks that were impacted by lower margins, US pricing pressure and slower launches, which is also reflected in a strong price correction for the four in the last 2 months.
Over the years, India’s domestic pharmaceutical market has seen strong growth as penetration increased and the fund gained exposure to the same set of stocks mentioned, which also have a strong domestic presence. Even, Aurobindo Pharma seems to be targeting the market in the next three years.
The fund invested almost 22% in January 2022 in hospitals and diagnostics companies. These companies should benefit from the growing penetration of healthcare services over the long term, but are currently at a higher valuation since the pandemic. Compared to the first part of the decade, the fund seems to invest a lower proportion in companies of multinationals, but which still represents 9%, which implies a higher growth potential for national companies.
As companies circumvent weaker growth in US markets and look for different niches to counter the same, the fund may offer diversified growth potential in the healthcare sector. The recent corrections in the pharmaceutical industry and the coming worries about inflation also argue in favor of investing in defensive sectors.
Note that sector funds carry high risk as diversification is limited and the sector itself may generate negative returns over several years and investments should be made within the overall portfolio allocation strategy and entered into the correct moment.
February 19, 2022