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The anti-ageing formula of pharma mutual funds - Outside View by PersonalFN
 
 
The anti-ageing formula of pharma mutual funds

Past three years have been quite eventful for the global economy and financial markets. The edgy economic recovery in the U.S. led by its ballooning debt-to-GDP ratio (of nearly 98%), dwindling economic growth rate (of mere 0.20% in the last quarter i.e. April 2011 to June 2011 along with a debt-overhang situation in the Euro zone have rayed financial crisis and hindered the bull run in equities across the globe. While the Indian stock markets have sailed this turbulence well, the recovery still looks fragile as dark clouds of global economic uncertainty (from developed economies) still remain. India has escaped relatively unscathed, but many sectors have suffered severely during the downturn.

Sectors such as real estate, power and capital goods which were the investors' favourites in the last bull run have been completely gone out of flavour of late. However pharma has been the only sector which has been held up during this descending trend of the Indian equity markets, thereby proving to be defensive and thus taking care of the health of investors' portfolio.


BSE Healthcare -A Steady Performer
Base: Rs100
(Source: BSE website, PersonalFN Research)

Indices Value of Rs 100
invested on Sept 5, 2006
BSE BANKEX 209
BSE Auto 172
BSE Healthcare 166
BSE Capital Goods 158
BSE Metal 151
BSE 100 148
BSE Sensex 144
BSE Power 120
BSE IT 116
BSE Realty 45
NAV as on September 8, 2011
(Source: BSE website, PersonalFN Research)

In fact over a 3-Yr time frame, BSE Healthcare index has landed in the top-3 performing indices after resilient performance by banking and financial services sector (due to prudent policy measures adopted by Reserve Bank of India) and auto sector (due to promising consumption story in India).

This blockbuster success of pharma funds is mainly attributed to the inherent strengths of the Indian pharmaceutical industry. The Indian pharmaceutical industry ranks 3rd across the world in terms of volumes and 14th in terms of value in accordance to the latest data published by departments of Pharmaceuticals, India.

Despite being fragmented, Indian pharma sector is robust on exports in approximately 200 countries and has presence in some key pharma markets such as U.S., Japan, Australia to name a few. These markets are highly regulated and have high entry barriers, but nonetheless our Indian pharma companies have managed to spearhead in their territory, thanks to
  • Favourable policy initiatives by the Government
  • Technological and product excellence
  • Skilled and cheap manpower
  • Ability to serve the mature markets
How the path for the growth of Indian pharma sector was paved?

In 1999, in a landmark decision, India took some legislative measures to fully comply with the obligations imposed by the General Agreement on Tariffs and Trade (GAAT). The measures were in concurrence with the process of liberalisation (initiated in 1991) and India pledged to comply with the international patent laws by January 2005. These policy measures helped Indian pharmaceutical industry to overhaul its business operations. These new legislative measures resulted in creating an environment which encouraged Foreign Direct Investment (FDI) in the Indian pharmaceutical sector, promote research and development activity and boost growth.

Recognising the potential of these policy initiatives in bringing about far reaching effects on Indian pharma and healthcare industry, mutual funds too launched pharma sector funds from the year 1999 onwards, and since then there has been unprecedented growth in Indian pharma industry.

Rising disposable income, growing awareness about healthcare among Indian masses, growing generics market in mature economies and strong product portfolio of Indian pharma companies have presented tremendous opportunities for promising growth of the industry.

How have pharma funds fared?
Scheme Name Date of inception 6- Mths(%) 1-Yr(%) 3- Yrs (%) 5-Yrs (%) SI (%) SD Sharpe Portfolio T/O Ratio
Reliance Pharma(G) 08-Jun-04 8.6 5.2 31.1 23.1 26.6 8.10 0.27 41.00
Franklin Pharma(G) 21-Apr-99 4.4 5.2 27.3 17.1 15.8 6.81 0.28 8.74
UTI Pharma & Healthcare(G) 01-Aug-05 5.3 10.0 17.7 12.6 25.2 6.13 0.18 77.10
SBI Magnum Pharma(G) 31-Dec-04 9.3 11.6 12.5 5.0 11.2 9.33 0.11 46.00
BSE Health Care - 3.0 6.3 12.1 10.7 - 7.39 0.11 -
NAV data is as on September 8, 2011. Standard Deviation and Sharpe ratio is calculated over a 3-Yr period.
Risk-free rate is assumed to be 6.37%
Source: ACE MF, PersonalFN Research

Hence even when we judge the performance of pharma funds, they have accelerated on the return front across time frames. Over 3-Yr and 5-Yr time frame, Reliance Pharma Fund has topped the category by delivering returns of 31.1% and 23.1% over the respective time frame, followed by Franklin pharma at the second position. UTI Pharma & Healthcare and SBI Magnum Pharma however have been average performers, especially over a 5-Yr time frame.

Interestingly while most pharma mutual funds have been to deliver appealing returns, so far they haven't exposed their investors to a very high risk (as revealed by their Standard Deviation) thereby leading them to provide luring risk-adjusted returns (as revealed by their Sharpe Ratio) as well.

Portfolio characteristics and strategy:

Being a sector funds they all have followed a top-down approach, but the market cap bias is different in each fund. For instance Reliance Pharma Fund and Franklin India Pharma Fund which have accelerated on the returns have maintained a balance between allocating towards large caps and midcaps. Whereas UTI Pharma& Healthcare Fund and SBI Pharma Fund have adopted a more defensive stance by predominantly holding their assets in the large cap domain where they have allocated 60.0% and 61.8% respectively. Interestingly while clocking enticing returns, none of the pharma funds have indulged in aggressive churning of portfolio.

Common stocks held by pharma funds
Common Holdings As a % of Total Corpus Weight in BSE HealthCare (%) Weight in BSE 100 (%)
Franklin Pharma (G) Reliance Pharma (G) SBI Magnum Pharma (G) UTI Pharma & Healthcare (G)
Cipla Ltd. 3.8 4.4 6.6 11.4 12.7 0.8
Dr Reddy'S Laboratories Ltd. 8.2 4.3 15.2 13.4 15.8 0.9
Glaxosmithkline Pharmaceuticals Ltd. 2.6 3.3 3.9 7.3 7.5 0.5
Lupin Ltd. 7.4 2.9 9.8 8.3 9.9 0.6
Sun Pharmaceutical Inds. Ltd. 5.0 7.8 10.9 11.8 17.0 1.0
Common holdings as on July 31, 2011, Index weights as on September 8-2011
(Source: ACE MF, BSE website, PersonalFN Research)
Interesting facts:

Thus the common holdings held by the respective pharma funds are top-5 constituents of BSE Healthcare index which compose about 63.3% of the index. But, their weight in BSE 100 (a broader diversified Index), is minuscule at 3.8% thereby being relatively insignificant in the broader index.

Performance across market cycles
Scheme Name Bull Bear Bull
  01/Aug/05 To 09/Jan/08 09/Jan/08 To 09/Mar/09 09/Mar/09 To 08/Sep/11
Franklin Pharma(G) 13.0 -28.0 55.8
Reliance Pharma(G) 32.9 -38.0 61.5
SBI Magnum Pharma(G) 19.2 -53.7 53.8
UTI Pharma & Healthcare(G) 11.8 -26.3 41.0
Category Avg of Pharma Funds 19.2 -36.5 53.0
Category Avg of Opportunities style diversified equity fund 54.2 -57.1 36.9
BSE Health Care 16.5 -36.5 41.9
BSE-100 52.5 -58.1 36.1
(Source: ACE MF, BSE website, PersonalFN Research)

The study of performance across market cycle reveals that during the exuberant bull phase of 2005 to 2008 (of the Indian equity markets), most pharma funds didn't deliver stellar returns. This was mainly because, the rally was exuberant in other sectors which was been able to capture by "opportunities style" diversified equity funds, which reflects in their category average returns. However, when the Indian equity markets experienced a turbulent patch (from January 2008 to March 2009), pharma funds were successful in arresting the downside risk due to their defensive trait. And now in the present bull rally (since March 9, 2009) they have in fact accelerated on the returns as defensive themes are preferred which in turn have led them to perform better as against "opportunities style" diversified equity funds.

Challenges faced by the Pharma Sector:

But while they have performed well in the present bull rally it is imperative to recognise the challenges which the Indian pharma sector faces.

It is noteworthy that pharma sector is highly regulated and thus sensitive to the regulatory actions. Unfavourable rulings and judgements impact the performance of the company and thus affect their stock prices negatively. Chart given below depicts how the stock of a well reputed company like Ranbaxy Laboratories Ltd., was hammered after the U.S. health regulator precluded it from selling two of its drugs in the U.S. market in the year 2008.

BSE Healthcare -A Steady Performer
(Source: BSE website,PersonalFN Research)

Similarly, when the research & development (R&D) fails to bring desired results in the discovery of a new drug, it adversely impacts the stock of a company as the exorbitant amount spent on R&D goes in vein. For instance when Glenmark Pharma's drug to cure lung disease failed, the stock was battered in 2009.

(Source: BSE website, PersonalFN Research)

Moreover at the recent Pharma Summit 2010 - organised by the Confederation of Indian Industry (CII) has cited the following challenges for the Indian pharma industry:
  • Foreign companies entering India with their generic market portfolio and soaring competition
  • Counterfeiting in products
  • Labour attrition
  • Infrastructure bottlenecks
The Verdict...

Hence while pharma funds have performed well in the present bull rally, their performance is closely linked to the fortune of the industry. Currently the Indian pharma industry has enablers as cited in Pharma Summit 2010 - which are:
  • Favourable socio-economic environment at the back of strong and growing economy
  • Changing disease profile
  • Growing middle class population with higher disposable income to afford quality healthcare
  • Penetration into the rural markets
  • Increase in Government spend on healthcare infrastructure
  • Deepening of health insurance
But the regulatory actions - both in India as well as abroad pose to be a risk for the pharma sector, which hampers some stocks in the underlying portfolio of pharma funds, which as such has a limited stock selection universe of about 20-25 stocks, thereby exposing them (pharma funds) to high concentration risk.

Hence we believe that while you may want to take opportunities present in the pharma sector, we think that opportunities style diversified equity fund would do good to your portfolio, due to their very trait of investing across sectors and market caps. This safeguards your investments against the vagaries of sector bets, and also powers your portfolio with the opportunities present in across sectors which also helps to reduce sector specific risk thereby enabling to ease the overall risk of your portfolio.

PersonalFN is a Mumbai based personal finance firm offering Financial Planning and Mutual Fund Research services.

Disclaimer:
The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

 

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