Pharma as a theme is booming as investors are rushing towards defensive stocks amid the uncertainty caused by the ongoing Covid-19 pandemic. As a result, pharma sector funds have outperformed all other mutual fund categories in the last one year.
One of the promising funds in the pharma fund category is Aditya Birla Sun Life Pharma & Healthcare Fund. The scheme was launched in July last year and has given over 45% return in the last one year. Let us understand more about the sector and what has worked for ABSL Pharma & Healthcare Fund from Dhaval Shah who manages this fund.
What is your near-term and long-term outlook on the pharma sector?
Pharmaceuticals sector has seen a euphoric rise post the covid-19 pandemic. Two big trends stand out in the sector over the last couple of months – a) resilience of domestic demand – all domestic oriented franchises saw little dent in sales despite decline in promotion expenses indicating the robustness of branded portfolio across therapeutic segments and b) improved export environment – companies got long awaited product approvals especially in respiratory and biologics segment which are fairly complex in nature. Also, Active Pharma Ingredient (API) segment saw customers stocking up more inventory to cover themselves of any further disruption in supply chain which has led to a massive re-rating of many API focused companies. Non pharma healthcare companies in Hospitals, Diagnostics and Wellness has seen demand disruption of regular non-covid business and we expect them to stabilize in second half of the financial year.
Over the long term, India, as a world leader in generic medicines, is on a strong wicket as we scale our competencies from finished dosages like capsule and tablets to complex molecules in injections, opthalmic solutions, transdermals and biosimilars. We can also conquer lost share in API and specialty chemicals from China which can be an added booster to the growth hypothesis.
Why does it make sense to invest in a pharma fund at this point?
We see the pandemic throwing up interesting trends that we hope India would be able to capitalize on. Over the last many months, Indian companies have provided large number of molecules at global scale to fight the pandemic. This would help establish strong customer and regulatory relationship especially in Developed Markets and articulate their importance in global supply chain to provide adequate supply at affordable prices. Besides, China is a large player catering to 65-70% of global Active Pharma Ingredient (API) market and a world leader in Specialty Chemicals. We see this changing over the next few years as companies across the world would want to hedge their supply chains. India has a unique opportunity to step up and build capability and capacity to meet such a requirement. Net-net, we see that the business environment for these sub-segments has improved materially over the last 12 months and would continue to think that investor should participate in pharma and healthcare opportunity over the long term.
Do you think that the recent spike in the pharma sector is not cyclical?
Recent spike in the pharma sector is due to positive earnings surprise vs street expectation. Earnings beat have happened on following counts. First, domestic oriented business had handsome earnings beat as sales were not impacted much but they saw massive reduction in promotion expenses due to inability of the field force to operate during the quarter which is transient in nature. 50-60% of the field force is back to work post opening of lockdown and would expect normalization to happen over the next few months. Second, API companies reported robust sales growth with sharp improvement in margins which is due to high inventory stocking by customers in some cases at higher prices too to secure themselves from any potential supply disruptions. 7-8% currency depreciation during the quarter as acted a tailwind to further bolster these numbers. While we expect some of these gains to taper off in few quarters, we think many API & CRAMS players would also see share gains from China which will aid future growth. Third, some of the export-oriented formulation companies saw complex product approvals and resultant sales traction which should continue for foreseeable future too.
In terms of valuations, how are pharma and healthcare sector stocks placed at this point?
A year back we had argued that investment in the sector makes immense sense as sector was available at attractive valuations with improving fundamentals. Stocks have got re-rated materially over the last year from 20% discount to long term average 12 months back to 10% premium to long term average currently. From current levels, investor should have a stock specific approach and focus on companies which are geared to capture growth with a robust product pipeline. It would also be pertinent to focus on companies which are focused on improving cash conversion and improving RoEs rather than ones which may opt for capex binge from current gains.
Aditya Birla Sun Life Pharma & Healthcare Fund has given around 45% return in the last one year. What has contributed to this performance?
Over the last 1 year, our portfolio has invested 71% in pharmaceuticals stocks. Of these, 60% was towards export-oriented companies and 40% towards domestic franchises. Post a good run in export-oriented franchises, we now have this split at 50:50. Contract Manufacturing (largely API focused) and specialty chemicals was 12% of the fund which also did well over the year. Hospitals, Diagnostics and Wellness at 14% of the portfolio did participate well until covid 19 but has corrected since then due to near term disruption.
How is Aditya Birla Sun Life Pharma & Healthcare Fund different from other pharma funds in the market?
Healthcare sector is made up of varied sub-segments like Domestic and Export of Pharma, Contract Manufacturing, Hospitals, Diagnostics, Wellness and Specialty Chemicals. We are running a much broader and diversified mandate on the overall healthcare sector with investment in non-pharma healthcare stocks at 30-35% of the fund. This is because we firmly believe many of these segments are under-represented in the overall construct of the index. Also, these segments are growing at a faster pace which would bridge the gap over the next decade. Besides, we also have flexibility to invest in international stocks. Our investment in specialty pharma company over the last year has done well and we are scouting for more investments in this space.
Who should invest in Aditya Birla Sun Life Pharma & Healthcare Fund? And why?
Pharma and Healthcare Fund is a thematic fund and is a high-risk high-return product. A thematic fund is more of a tactical play than a strategic one. We won’t advise first time investors to invest in this fund. Rather, this is for someone who already has a diversified portfolio and is looking at the sector because of its growth characteristics and could generate better risk adjusted returns. If you look at the 10-year history, healthcare index has outperformed the broader markets and we continue to think it would continue to do the same over the next decade.
How should distributors position this fund among their clients?
Being a thematic fund, we always advise our clients to invest in this fund with a 3-5 year time horizon. Distributors should understand investor’s risk appetite and recommend this fund to only those investors who understand the associated risk while investing in such a product.
