Pharma and healthcare funds have surged 16.6 per cent over the past year and 9.5 per cent over the past three months. Fund managers remain positive about the prospects of these funds.
“Healthcare remains a structural growth opportunity over the medium to long term, underpinned by improving access, greater affordability and a steady rise in demand for quality healthcare,” says Shibani Kurian, senior fund manager and head-equity research, Kotak Mahindra Ast Management Company (AMC).
Investors drawn to pharma and healthcare mutual funds by their recent returns should, however, pause before writing a cheque. “Two funds in this category may carry the same category label but have significantly different portfolio compositions, risk profiles and return drivers,” says Shubham Gupta, co-founder, Growthvine Capital.
Pharma-focused or broader healthcare exposure
Pharma-focused funds can benefit from new product launches and speciality medicines. “Pure pharma funds offer concentrated upside tied to US generic pricing cycles, export demand and patent pipelines,” says Abhishek Kumar, Securities and Exchange Board of India (Sebi)-registered investment adviser and founder, SahajMoney.com.
That upside comes with a cost, since the sector’s fortunes are tied closely to the US Food and Drug Administration (USFDA). “Pharma-focused funds are more sensitive to regulatory changes, USFDA issues and pricing pressures,” says Amitabh Lara, executive director, Anand Rathi Wealth.
Healthcare, as a category, is considerably broader. It spans generic and speciality pharma, active pharmaceutical ingredients (APIs), contract development and manufacturing organisations (CDMOs), hospitals, diagnostics, healthcare services, and health insurance. Healthcare funds offer greater diversification “Hospitals and diagnostics can benefit from rising healthcare spending, insurance penetration and formalisation of the sector,” says Lara.
Investors seeking participation in domestic health services should prefer broader healthcare funds.
Largecap stability or midcap and smallcap punch
Fund portfolios also differ by market-cap orientation.
“Largecap-oriented funds offer greater stability, provide more resilient cash flows and generally offer superior liquidity during market drawdowns,” says Kumar. The trade-off is that these funds can have capped upside during strong sector rallies.
Midcap and smallcap-oriented funds can offer sharper earnings acceleration. “They can create higher alpha opportunities in niche chemical and API segments,” says Kumar. But they can also suffer severe price volatility and face illiquidity during sector downturns.
Conservative investors using the sector as a defensive satellite holding should prefer funds focused on largecap stocks. Aggressive investors with an investment horizon beyond five years can consider funds with greater midcap and smallcap exposure.
Domestic focus or global diversification
Global passive healthcare funds can provide exposure to overseas healthcare businesses. “Global healthcare gives access to global innovation, patented drugs and medical technology that may be unavailable in India,” says Kumar. International exposure also offers geographic and currency diversification.
The flip side is that it introduces cross-border currency risk, global regulatory uncertainty and domestic tax disadvantages. Investors without a dedicated offshore equity allocation can use global healthcare exposure to spread geographic risk. “Investors seeking India’s domestic manufacturing and healthcare-delivery tailwinds can stay with pure domestic portfolios,” says Kumar.
Active or passive fund?
Active funds let the manager select stocks and adjust positions in an attempt to outperform the benchmark. “They allow the fund manager to sidestep companies facing adverse USFDA observations,” says Kumar. Cash levels can be managed during downturns. The trade-off is that active funds generally come with higher expense ratios.
Passive index funds provide cost-efficient exposure to a predefined sector basket. “They remove fund-manager bias,” says Kumar.
Their limitation is structural. “Passive funds are restricted by index composition and have limited flexibility to avoid challenged companies or segments,” says Lara.
Investors concerned about company-specific regulatory risks can prefer active management, while cost-conscious investors seeking exposure to a predefined market basket should consider passive funds.
Look beyond recent returns
Rolling returns help assess the consistency of a fund’s performance. “Investors should use three- and five-year rolling returns across multiple market cycles instead of relying on trailing point-to-point returns,” says Kumar. They should also evaluate the consistency of alpha generation across market cycles.
“Maximum drawdown helps evaluate capital vulnerability during sector troughs,” says Kumar.
The Sharpe ratio helps assess excess return relative to volatility.
Weigh costs and fund size
High costs can erode returns. “Even a 0.5 percentage point annual difference in expense ratio can meaningfully affect long-term returns,” says Aditya Agarwal, chief investment officer, Avisa Wealth Creators.
Expense ratios should be viewed in the context of the returns generated. “A somewhat higher expense ratio can be acceptable if the manager has demonstrated consistent alpha after costs,” says Gupta.
Portfolio turnover should not be excessive. “Turnover consistently above 100 per cent warrants closer examination,” says Agarwal. High turnover is not necessarily negative if it improves risk-adjusted returns. “Additional trading activity should actually add value rather than simply increasing costs,” says Gupta.
Vet the fund manager’s record
Investors should examine the manager’s experience in the pharma and healthcare sector. Previous experience as a pharma or healthcare analyst can indicate a deeper understanding of company-specific and sector-specific risks. “A consistent investment approach is more important than short-term outperformance,” says Harsh Vira, chief financial planner and founder, FinPro Wealth.
Investors should also check the manager’s tenure with the fund. “Verify that the historical performance being evaluated was generated under the current manager,” says Gupta. He adds that the manager should have demonstrated an ability to generate consistent alpha over the benchmark rather than merely benefiting from a sector-wide rally. Nikhil Mathur, fund manager and senior equity analyst, HDFC AMC suggests that a recent manager change should be checked because it may alter the fund’s future style and risk profile.
Who should invest
Pharma and healthcare funds are best suited to aggressive investors who are comfortable with the higher risk of sectoral funds. “Investors should be able to withstand sector-driven drawdowns and market-led corrections,” says Mathur.
These funds suit investors who already have a diversified core portfolio, with relatively low existing sector exposure and strong long-term conviction, and who want pharma or healthcare only as a satellite allocation. Vira is of the view that first-time investors or those seeking a well-diversified portfolio should avoid making them a core holding.
Decide allocation and horizon
Investors should limit pharma and healthcare funds to around 5-10 per cent of the overall portfolio, depending on risk appetite and conviction. “Given the fund’s very high risk rating and sector-cycle dependency, the investment horizon should be at least 5-7 years to allow the underlying pharma up-cycle to play out and absorb interim volatility,” says Mathur.
The writer is a Mumbai-based independent journalist