Pharma Funds outperformed Equity funds

When the broader markets had given negative or near-zero returns; one fund category delivered the returns of 55-60% in the last one year. And this mutual fund category is Pharma Funds. Naturally, looking at the past performance of these funds, a lot of investors want to invest in Pharma Funds. While they hope for past performance to repeat, that seldom happens. Considering the current market scenario, does it make sense to invest in Pharma Funds now? If yes, then how much exposure should you take to these funds? What type of risk exposure you should expect while investing in Pharma Funds? We will understand all these factors with this blog.

Pharma Funds and their Performance

Pharma funds are sectoral funds that invest only in stocks from the Pharmaceutical sector. Currently, about 9 AMCs offer Pharma / Healthcare & Pharma funds. As a category, Pharma has given exceptional returns over last year. Below are the top 5 funds based on AUM and their performance snapshot:

Based on the above data, short term performance of pharma funds has been better than the diversified equity funds. But this performance is solely based on only one factor: Corona Virus Pandemic. The worldwide pandemic affected the stock markets adversely but Pharma stocks continued to do well. Pharma as a sector is considered to be a defensive sector which means that it usually stays stable during extreme market cycles.

Additionally, with Hon. PM Narendra Modi’s Atmanirbhar Bharat campaign, Pharma industry came in focus. A new INR 140 billion fund was set up to help the pharma industry with the manufacturing of Active Pharmaceutical Ingredients (APIs). This also helped Indian pharma stocks give superior performance.

But what about the risks associated with Pharma Funds? Here are the risks you should know about before investing in these funds.

Risks in Pharma Funds

One major risk in Pharma funds is concentration risk. This concentration is in two factors: Investment in only one sector and Investment in only a selected number of stocks.

Since investment is only in Pharma stocks, there is a significant risk exposure in these funds. When at some point, pharma stocks go down, the entire fund performance goes down. Secondly, the underlying portfolio in the fund also has very few stocks. That means every stock has very high exposure and if one stock goes down, it has a reasonable impact on fund performance. Here’s a portfolio snapshot of above-mentioned Pharma Funds:

An easier way to interpret this data is: lower the number of stocks, higher is the concentration risk in the fund. Also,  exposure to the top 10 stocks is more than 50% for every fund. This indicates that the majority of the performance of these funds is driven by the top 10 stocks. This adds to the concentration risk we mentioned earlier.

Should You Invest in Pharma Funds Now?

If we were to look at the Pharma fund category from a risk profiling angle, then investors with a conservative risk profile should stay away from these funds. The risk exposure of the funds and resulting volatility can get overwhelming for a conservative investor. Hence, Conservative investors will be better off by investing diversified equity funds instead of going for sectoral funds like Pharma.

For investors with an aggressive risk profile, the reasoning to invest in pharma funds goes beyond risk appetite. With any sectoral fund, the timing of entry and exit is very important to generate good returns. Needless to say, no one can perfectly time the market. If the only purpose behind investing in Pharma funds is to generate high returns over the short term, then it may be a wrong approach to take.

Currently, with a growth of 60% in a year, it is highly unlikely that Pharma funds will give similar returns in the next one year. Even if you decide to invest in these funds, it is important to realign the return expectations over the short term. Hence, if you are an investor with an aggressive risk profile and if you decide to invest in Pharma Funds, you need to be ready for extreme volatility over the short term.

If you want to explore Pharma Funds in more detail then reach out to our research team and get personalized insights and recommendations.