Should You Invest in Pharma Funds?

Are you looking for new opportunities to create wealth? Do you seek an aggressive investment to match your risk tolerance? You may consider putting your money in pharma funds. It invests most of your money in stocks of pharmaceutical and healthcare companies. The pharma fund category has offered average returns close to 61% in the last one year.

You may find some open-ended pharma funds to have beaten the BSE Healthcare Index in the past year. However, pharma funds may be extremely risky, and you could lose a lot of money if the theme suffers. You may consider investing in pharma funds only if you are an aggressive investor. 

What are pharma funds?

Pharma funds are a sectoral mutual fund that puts your money in stocks of companies in one sector. For example, the banking sector funds invest in stocks of public and private sector banks. Pharma funds invest in the equity shares of pharmaceutical and healthcare companies. You would find a small allocation for debt and money market instruments. 

Pharma funds generally focus on the market leaders in the pharmaceutical space. The fund manager puts money in a mix of pharma stocks across market capitalisation, to generate returns for investors, depending on the market conditions. The aim is to get a higher return as compared to the benchmark indices such as S&P BSE Healthcare and the Nifty Pharma. 

Why could pharma funds do well?

The government is focusing on the coronavirus pandemic and has increased spending on healthcare. India aims to spend 2.5% of the GDP on public health by the year 2025. It currently spends 1.15% of the GDP on public healthcare. However, spending on healthcare has gone up across the world, which is good for the pharma sector in India. 

A pharmaceutical drug that contains the identical chemical substance as a drug produced under a patent is a generic drug. India exported drugs and pharmaceutical products worth $6 billion to the USA in the fiscal year 2019. The US generic drug market was worth a whopping $115.2 billion in 2019 and could exceed $190 billion by 2024. However, large Indian pharmaceutical companies exporting pharma products to the US underperformed between the years 2015 to 2019. 

The USFDA, which is the food and drug administration agency in the USA, sent 19 warning letters to Indian pharma companies in 2019. The USFDA sends warning letters if Indian pharmaceutical companies exporting to the US, fail to comply with strict quality standards at pharmaceutical plants in India. However, the USFDA issued warning letters to Indian pharma companies in 2019, based on inspections conducted in the previous year. 

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You may find the USFDA to be lenient towards Indian pharma companies after the coronavirus pandemic. It is because USFDA wants to ensure the supply of critical drugs in the US. However, pharma companies must adhere to the necessary quality norms. 

Indian pharma firms may benefit from the US-China trade war. China is a big supplier of active pharmaceutical ingredients (API) and formulations to the US market. Indian pharma companies may benefit from the trade war as they could become a source of APIs for the US market. 

You may consider looking at the hospital sector in India. It is poorly penetrated with just 1.3 hospital beds for every thousand people. India must have at least three hospital beds per thousand people to adhere to WHO standards. India is striving to achieve two hospital beds per thousand people, over the course of the next decade.

It translates to millions of new hospital beds, which is good for the pharma sector in India. You may also consider the growing healthcare diagnostic space, with testing being ramped up after the coronavirus pandemic. You may expect pharma companies to do well, with the shift from the unorganised to the organised sector, in the healthcare diagnostic space. 

The Indian pharmaceutical industry could export medicines and other goods worth a whopping $25 billion in the current financial year. You also have some of the world’s top pharmaceutical companies showing a nearly 95% efficacy for their COVID-19 vaccines. The US, India, and several other countries could soon vaccinate their citizens. You may expect the global economy to bounce back over some time. 

Should you invest in pharma funds?

• Pharma funds may invest at least 80% of the total assets in the specified sector as per the SEBI mandate. You may consider investing in pharma funds only if you are an aggressive investor with a high-risk tolerance.
• You may consider putting your money in pharma funds if you have adequate knowledge of the pharma industry. Investing in pharma funds could mean taking a calculated risk in one sector.
• Invest in pharma funds only if you are willing to invest for the long-term.
• The pharma sector could perform well in some time because of the coronavirus pandemic. However, it is a volatile investment, and you could lose money if the pharma sector underperforms.
• You may consider investing in pharma funds through a systematic investment plan or SIP. It helps you stagger your investment in the pharma fund over some time.
• You could invest around 5%-10% of your portfolio in pharma funds. However, pharma funds are suitable only if you have a high-risk appetite.
• You may consider checking the track record of the AMC and the fund manager before investing in pharma funds.
• Invest in pharma funds only if your overall equity portfolio doesn’t have sufficient exposure to the healthcare sector. However, a large-cap-oriented portfolio has an allocation of around 3%-5% to the pharma sector. Mid-cap and multi-cap funds may have a higher exposure to the pharma and healthcare sectors.

Advantages of investing in pharma funds

• Pharma funds are a focused investment in one sector. It offers you the potential to earn a high return if the pharmaceutical and healthcare sectors do well.
• You may consider investing in pharma funds, instead of putting your money directly in stocks of pharmaceutical companies. You could avail of the services of a fund manager if you invest in pharma funds.
• Pharma funds invest in stocks of pharmaceutical companies across market capitalisation. You may earn a higher return as compared to a benchmark index.
• You may diversify your portfolio with pharma funds if it lacks sufficient exposure to the pharmaceutical and healthcare space. It could be an add-on to your existing portfolio.

Disadvantages of investing in pharma funds

• Pharma funds invest in only one sector. You could lose money if the pharma and healthcare space fails to perform over some time. For example, shares of top pharma companies exporting pharmaceutical products to the US, fell when the USFDA issued warning letters against their pharmaceutical plants.
• Pharma funds are an extremely volatile investment. You are putting all your money in a single sector instead of diversifying your investments.
• Pharma funds are a bet on a particular sector. You may suffer a heavy loss if you fail to time your exit from the fund.
• Pharma funds may be a suitable investment if you have sound knowledge of the particular sector. It could be extremely risky if you put your money without studying the pharmaceutical industry.
• Pharma funds may have a higher expense ratio as compared to other mutual funds.

Tips for picking pharma funds

• You may consider studying the portfolio of the pharma fund. Pharma funds may invest in pharma stocks across market capitalisation. It would help if you studied the top holdings of the pharma fund.
• You could study the track record and the investment style of the fund manager of the pharma fund.
• You may opt for a relatively large-sized pharma fund. Check the assets under management (AUM) and the track record of the mutual fund house.
• You may pick a pharma fund if it performs well over five or more years. However, past performance doesn’t mean the fund could perform in the future.
• Study the expense ratio of the pharma fund. It is the annual fee charged by the mutual fund to manage the investment.
• You may consider investing in the pharma fund through the SIP. It helps you avoid timing the market.

You could invest in pharma funds if you expect strong growth from the pharmaceutical and healthcare sector. However, you may do your research before selecting the pharma fund. Pharma funds bet on one particular sector and are a hazardous investment. You may invest if it matches your risk tolerance.

Invest in pharma funds if your portfolio lacks adequate exposure to the healthcare space. In a nutshell, one sector cannot perform well across all market cycles. You may consider your exit strategy from the investment when putting money in pharma funds. 

For any clarifications/feedback on the topic, please contact the writer at cleyon.dsouza@cleartax.in