Pharma Mutual Funds: Invest Now Or Later?

Investing in pharma mutual funds is a risky endeavour due to the lack of diversification in the portfolio. Pharma sector mutual funds predominantly invest in stocks of companies within the pharma sector. While the Indian pharmaceutical sector holds significant growth potential, it is crucial to acknowledge the associated risks and uncertainties. The performance of the pharmaceutical sector is susceptible to market pressures, regulatory changes, and pricing pressures. Before investing, it is essential to conduct thorough research and assess your risk tolerance. While pharma funds offer attractive returns, they are suitable only for experienced investors with a good understanding of the industry and its dynamics.

The risks of investing in pharma mutual funds

Pharma mutual funds are a type of sector fund that invests primarily in the stocks of companies in the pharmaceutical and healthcare sectors. While the pharmaceutical industry in India has significant growth potential, investing in pharma funds carries several risks that investors should be aware of before committing their money.

Lack of Diversification

Sector funds, by definition, lack diversification. Pharma mutual funds invest a large portion of their assets in the stocks of companies within the pharmaceutical industry. This means that if the sector experiences a downturn, the fund cannot invest elsewhere, and the portfolio's stocks will decline with nothing to cushion the blow.

High-Risk Investment

Due to the lack of diversification, pharma mutual funds are considered high-risk investments. They are suitable only for experienced investors with a good understanding of the pharma industry and a high-risk tolerance. Even for those well-versed in the industry, exposure beyond 10% of your portfolio is not recommended.

Regulatory Changes and Competition

The pharmaceutical industry is heavily regulated, and changes in these regulations can impact profitability. Indian companies also face stringent competition domestically and internationally, requiring them to constantly innovate and enhance efficiency to maintain their market presence.

Volatility

Pharma funds are equity schemes, which tend to be highly volatile in the short term. Investors should be prepared to stay invested for the long term, typically at least five years, to ride out the fluctuations and maximise the potential for significant returns.

Stringent Government Controls

The Indian government enforces price controls on certain essential drugs, which can restrict profit margins for pharmaceutical companies. Additionally, the industry must comply with strict quality standards set by regulatory bodies like the USFDA. Failure to meet these standards can result in warning letters and negatively impact the performance of pharma funds.

In conclusion, while the pharmaceutical sector in India holds growth potential, investing in pharma mutual funds carries significant risks. Investors should carefully consider these risks, conduct thorough research, and assess their risk tolerance before committing their money to pharma funds.

The benefits of investing in pharma mutual funds

Pharma mutual funds are a type of sectoral or thematic fund that invests predominantly in companies within the pharmaceutical industry. While investing in pharma mutual funds carries a high level of risk, there are several benefits to allocating a small portion of your portfolio to this fund category.

Exposure to Leading Pharma Companies

By investing in pharma funds, you gain easy access to the top-performing stocks of industry-leading pharmaceutical companies. This allows you to benefit from the potential growth of these established industry leaders.

Easy Portfolio Diversification

Sectoral pharma funds simplify the process of diversifying your portfolio to include the pharmaceutical sector. This is less cumbersome than individually assessing different pharma stocks and deciding which companies to invest in.

Expert Fund Management

Pharma sector funds are typically actively managed by expert fund managers who make crucial decisions about stock selection, asset allocation, and investment redemption. You can benefit from their specialised knowledge and experience in this field.

Potentially Stable Growth

The pharmaceutical industry is considered a defensive market segment, characterised by constant demand and reliable income streams. Unlike cyclical sectors that experience volatile phases of upturns and downturns, defensive sectors like pharma offer relatively stable growth potential.

High Returns

The pharma fund category has offered average returns close to 61% in the last year, outperforming the BSE Healthcare Index. Additionally, the worldwide demand for generics, government backing, and the sector's defensive characteristics have contributed to robust performance in the Indian stock market.

Long-Term Investment

Pharma funds are suitable for investors with a long-term investment outlook. While the pharmaceutical sector may experience fluctuations, a long-term perspective helps smoothen out short-term volatility and allows for potential growth over time.

Focused Investment

Pharma funds offer a focused investment strategy by concentrating on a specific sector. This narrow focus provides the potential for earning high returns if the pharmaceutical and healthcare sectors perform well.

Access to Expertise

Investing in pharma funds grants you access to the expertise of fund managers who closely monitor the industry and make informed investment decisions. Their insights can help you navigate the complexities of the pharmaceutical sector.

Global Demand and Growth

The ongoing surge in the Indian pharmaceutical sector has created wealth for investors, particularly those invested in healthcare companies. Additionally, the sector benefits from the global demand for generics and the US-China trade war, which may favour Indian pharma companies as a source of active pharmaceutical ingredients (APIs) for the US market.

Defensive Investment Theme

The pharmaceutical and healthcare sectors are defensive in nature, as people continue to seek medical assistance and consume medications even during challenging economic times. This consistent demand makes these sectors relatively stable investment choices.

Government Support

The Indian government has increased spending on healthcare, with a goal of allocating 2.5% of the GDP to public health by 2025, up from the current 1.15%. This increased government support bodes well for the pharma sector.

Innovation and Efficiency

To maintain their market presence in the face of stringent regulations and competition, Indian pharmaceutical companies must consistently innovate and enhance efficiency. This drive for innovation and improvement can contribute to the sector's long-term growth and resilience.

The outlook for the pharmaceutical sector in India

Market Position and Size:

• India's pharmaceutical sector is the world's third-largest by volume and 14th largest by value.
• The industry is expected to reach a value of $65 billion by 2024 and $120-$130 billion by 2030.
• India accounts for 20% of the global supply of generic medicines and is the largest provider of these medicines globally.
• The country also has a strong presence in the vaccine market, contributing 60-70% of the WHO's demand for certain vaccines and holding a 20% share in the global vaccine market.
• India's pharmaceutical market is expected to exhibit a 4.70% annual growth rate between 2024 and 2029.

Government Support and Policies:

• The Indian government has implemented various schemes and policies to support the pharmaceutical sector, such as the Production Linked Incentive (PLI) schemes, the Scheme for Strengthening of Pharmaceuticals Industry, and the National Pharmaceutical Policy (2023).
• These policies aim to boost domestic manufacturing, promote research and innovation, enhance regulatory efficiency, and attract investments.
• The government has also liberalised Foreign Direct Investment (FDI) limits, allowing up to 100% FDI through the automatic route for Greenfield investments and 74% for Brownfield investments.

Research and Innovation:

• India's pharmaceutical sector has emerged as a global leader in research and innovation, driven by a robust scientific and technological base and growing government support.
• The government has schemes in place to promote industry-academia linkages for R&D and to establish specialised Centres of Excellence.
• The Biotechnology Industry Research Assistance Council (BIRAC) has facilitated R&D projects for drug discovery, and over the past five years, 17 pharmaceutical products or technologies have been developed through various schemes.

Manufacturing and Cost Competitiveness:

• India has cost-competitive manufacturing capabilities, with manufacturing costs 33% cheaper than Western markets.
• The country has a strong network of over 10,500 manufacturing facilities and is home to more than 3,000 pharma companies.
• India has the highest number of US-FDA-compliant plants outside the US, ensuring the quality and safety of its pharmaceutical products.
• The government has implemented schemes to boost domestic manufacturing of active pharmaceutical ingredients (APIs) and drug intermediates, with financial assistance of up to INR 1000 crore provided for the creation of common infrastructure.

Export Opportunities:

• India is a major exporter of pharmaceuticals, serving over 200 countries, including highly regulated markets such as the US, Western Europe, Japan, and Australia.
• India supplies over 50% of Africa's requirement for generics, about 40% of the US demand, and around 25% of all medicines in the UK.
• The country's pharmaceutical exports are expected to grow, driven by the increasing demand for generic drugs and the country's cost-competitive manufacturing capabilities.

In summary, the pharmaceutical sector in India has a positive outlook, supported by government initiatives, a strong domestic market, increasing exports, and a focus on research and innovation. The sector is well-positioned to continue its growth trajectory and play a significant role in the global pharmaceutical industry.

How to select the best pharma mutual fund

While the pharmaceutical industry in India has been troubled for some time, it still holds significant growth potential. However, investing in a sector is always risky, and pharma mutual funds are considered one of the riskiest types of mutual funds. Therefore, investing in pharma mutual funds is only recommended for experienced investors, and even then, not more than 10% of your portfolio should be in these funds.

If you are an experienced investor and want to select the best pharma mutual fund, here are some things to consider:

• Historical Performance: While historical performance does not guarantee future returns, it is still important to analyse how the fund has performed against its benchmark and peers. Look for funds that have consistently outperformed their benchmark and peers. This will also help you understand the fund manager's performance and the fund's behaviour across different market cycles.
• Investment Objective: Pharma mutual funds aim to capitalise on the long-term growth potential of the pharmaceutical industry. Fund managers hand-pick stocks based on a company's track record, management, growth prospects, and industry situation. As an aggressive investor, you should assess whether the fund's investment objective aligns with your own goals and risk tolerance.
• Suitability: Pharma funds are equity schemes and are therefore highly volatile in the short term. They are suitable for investors who want to diversify their portfolio, are willing to stay invested for the long term, and have a good understanding of the pharma industry. Before investing, carefully consider the suitability of the sector and the specific funds in relation to your investment portfolio, goals, and horizon.
• Broad Criteria: When deciding on a pharma mutual fund, look at criteria such as current industry trends, the fund manager's track record, and portfolio composition. Analyse the fund's exposure to stocks from the pharmaceutical industry, as this will impact the level of risk.
• Risk Analysis: Pharma funds are sector funds, which means they are highly exposed to the performance of the pharmaceutical industry. If the sector experiences a downturn, the fund manager cannot invest elsewhere, and your portfolio's stocks will also decline. Therefore, it is crucial to analyse the underlying risks of the sector and the fund before investing.
• ICICI Prudential Pharma Healthcare and Diagnostics (P.H.D) Fund
• Mirae Asset Healthcare Fund
• ITI Pharma & Healthcare Fund
• SBI Healthcare Opportunities Fund
• Tata India Pharma & Heathcare Fund

The suitability of pharma funds for your portfolio

Pharma funds are a type of equity fund that invests primarily in equity-linked instruments belonging to the pharmaceutical and healthcare sectors. They are considered a risky investment option due to their lack of diversification, as they invest a large amount of their assets in the stocks of companies involved in a specific industry. If the pharmaceutical and healthcare sectors underperform, investors in pharma funds stand to lose a significant amount of money.

Advantages of investing in pharma funds

• The pharmaceutical industry in India has diverse opportunities and strong growth potential, making it a worthwhile sector to explore.
• Pharma funds offer potentially attractive returns to investors who are willing to take a long-term approach to their investment.
• Pharma funds provide exposure to a range of leading companies in the pharma and healthcare sectors, reducing the risk associated with investing in individual companies.
• The demand for healthcare services is steadily expanding, and the growth prospects for the industry look promising.

Disadvantages of investing in pharma funds

• Pharma funds are an extremely volatile investment due to their lack of diversification.
• They are a bet on the performance of a specific sector, and investors may suffer heavy losses if they fail to time their exit from the fund.
• Pharma funds may have a higher expense ratio compared to other mutual funds.

Tips for investing in pharma funds

• Study the portfolio of the pharma fund, including its top holdings, the track record and investment style of the fund manager, and the size of the fund.
• Opt for a relatively large-sized pharma fund with a strong track record and assets under management (AUM).
• Consider the fund's performance over a longer period, such as five years or more, rather than just its past performance.
• Study the expense ratio of the pharma fund, which is the annual fee charged by the mutual fund house.
• Consider investing in the pharma fund through a Systematic Investment Plan (SIP) to stagger your investment over time and avoid timing the market.

In conclusion, pharma funds may be a suitable addition to your portfolio if you are an aggressive investor with a high-risk tolerance and adequate knowledge of the pharma industry. However, due to the high risk and volatility associated with these funds, it is recommended that they comprise only a small portion of your overall portfolio (around 5-10%).

Frequently asked questions