Pharma offers favourable long-term opportunities, says Shalesh Raj Bhan of Nippon India MF

Author: ETHealthworld l June 10, 2020 l Image Credits: Shuttestock 

Pharma funds are in enjoying their spot under the spotlight after a lull period in the last three to four years. These sector schemes have offered an average return of over 25% in the last year. Shivani Bazaz of spoke to Sailesh Raj Bhan, Deputy CIO – Equity Investments, Nippon India Mutual Fund, to get an insight into the prospects of the sector. Bhan manages Nippon India Pharma Fund that has assets worth Rs 2,851 crore under its management.

Most mutual fund investors are excited about the 25% plus returns offered by pharma funds in the last one year. Pharma funds also seem an obvious choice to invest because of the Covid-19 pandemic. Are good times finally back for pharma funds?
The pharma space is coming out of a very difficult phase in the last three to four years. While the sector was already recovering over the past 12 months on the earnings front, the stock prices were not factoring the recovery because of the narrow equity markets. This is one of the few sectors, where earnings can possibly double in a 4 to 5 year period with far greater visibility. The annual 8-10% price declines in the US markets have now normalized to a much more muted level of 3-4%, which is manageable through productivity and cost changes.

On the domestic market front, both volume and value growth are likely to continue for many years, given the under penetration and rising incomes. Hence, this sector is likely to see a good traction over the next three years. Post COVID, health is also top on the agenda for all across the world. Importantly, Indian pharma sector has stood out in these trying times and has gained prominence as the “Pharmacy to the World” due to its quality and scale.

The only trouble is that these funds have been struggling because of pharma companies' trouble with regulators abroad. Are these episodes behind us?Over the last 12 months a lot of FDA-related issues have seen resolutions. Being the critical lifesaving business, regulatory scrutiny will be a norm and Indian companies have significantly upgraded their process through investments in the last few years, which bodes well for the future.

Pharma is considered a defensive sector or an evergreen sector. However, that is not how it played out for investors. Please comment.
In the last three-four years, challenges were primarily related to the commodity generics product market like the US. Equity markets were imputing high valuations to commodity profits, which has now completely eroded. Domestic branded pharmaceuticals are a secular or defensive sector like the consumer sector. Given the rising share of India business in most companies from under 30% of estimated profits to closer to 50% plus, the overall profile of earnings has become more secular. With international markets also now becoming more profitable, overall earnings outlook has improved for the sector.

Should regular investors stay away from pharma funds - just like any sector funds? Are they meant for only very evolved or sophisticated investors?
While optically the pharma sector appears to be a single sector that is diversified into sub-segments like pure pharmaceutical business (domestic & international), hospitals, and diagnostics, or preventive wellness business. In fact if we analyse more in detail the domestic business is largely secular. While India is demographically a young country, the population above the age of 50 years is still a large number and with the higher incidence of chronic diseases in India, the pharma sector earnings from the domestic business have been getting more secular with contribution improving to 50-60% in most companies. Further, given the relatively secular nature of the underlying, long term growth opportunities, huge domestic under penetration, lower ownership etc, the sector presents an attractive proposition to all types of equity investors who have a medium to long term investment horizon. Investors should focus on their risk profiles to check for suitability.

Can an individual investor take a small exposure to pharma to diversify? If yes, how much exposure should one take?
Pharma is one sector where India has a competitive advantage globally. It also offers favourable long term opportunities due to the unfortunately high chronic disease rate and improving awareness of healthcare in India. Given that it’s a sector strategy, allocations to the same should be under 10% for investors, and should be made from a 3-5 year horizon. Further small investors can consider participating through systematic investment route (SIP or STP) over the next few quarters which help to even out the interim volatility.

Nippon India Pharma Fund has offered 30% in the last one. However, it had offered very low single-digit returns between 2017-19, and negative returns in 2016. Four years between 2012 and 2014 were fantastic for investors. Should investors be prepared for such a rollercoaster ride?
Analysed from a long-term perspective since its inception (June 5, 2004) Nippon India Pharma Fund has grown more than 18.6x (NAV Rs 186.20) and generated CAGR returns of 20.06% or in other words Rs 10,000 invested at inception would have been worth Rs 1.86 lakhs (all data as of May 31, 2020) thus illustrating the long term wealth creation possibilities. Any sector or theme-based fund can experience higher volatility as compared to diversified funds. As explained in the earlier responses, the pharma sector went through a challenging period over the last 4-5 years which impacted the returns. However, from the current context a lot of these challenges are normalizing and the sector offers reasonable growth possibilities even as a lot of other sectors have an uncertain outlook.

All the key triggers like earnings revival, reasonable valuations, increased focus on healthcare in backdrop COVID-19, low ownership etc indicate possibilities of a reasonable recovery over the medium term. Nippon India pharma fund is well diversified across market sub-segments (Domestic, International, Healthcare Services etc) and market capitalization ranges and is well positioned to capture the sector opportunities.

The virus scare is going to keep the focus on the pharma sector until a vaccine is found. Also, for some more time. Should investors take tactical exposure to the sector.We believe the sector should be evaluated from a fundamental point of view. All the challenges of the last few years are normalizing while the opportunities of under penetration, lower ownership and higher public/private investments provide a reasonable platform for revival. Further in times of lower growth possibilities across segments Pharma is one of the few sectors which has better growth possibilities supported by favourable earnings growth & reasonable valuations. Hence, we believe the sector should be considered for its fundamental possibilities.

What are the special measures taken by you to manage the inevitable downside in the fund due to the strict investment mandates during a downturn?
Nippon India Pharma fund adopts prudent risk management measures like diversification across various sub-themes like Branded & Generic businesses (Domestic & International), Hospitals, Diagnostics, Outsourcing etc. This diversification within the industry sub sectors to reduce impact of single events like policy changes, currency impact, etc. Single stock exposure is not more than 10% at the time of investment, thus ensuring lower concentration risk. Further our strong in-house research capabilities with extensive on ground research, interactions with pharma distributors/suppliers help in early risk assessment and portfolio rebalancing, if any.