Are Pharma & IT Funds Back In The Green?

While the period following the pandemic turned challenging for the pharmaceutical and information technology sectors, events in recent times have shaped out to be tailwinds for both these sectors and the mutual funds that invest in such sectoral themes. The following article highlights the reasons why these sectors may be back in favour among investors while also taking note of the red flags that need to be taken into account

In the wake of the waning of the pandemic and the global markets regaining their footing, the shine seemed to have dimmed on the IT and pharmaceutical funds, leaving many investors disheartened. But in the world of finance, where resilience often trumps adversity, a new chapter has begun to unfold. Since the onset of June 2023, these sectors, that were hugely underperforming, have staged a remarkable comeback, leaving astute investors wondering whether it’s time to revisit their investment strategies and set sail toward the horizon of renewed potential.[EasyDNNnews:PaidContentStart]

Starting 2020 till the end of 2021, the healthcare and IT equity indices gave phenomenal return. The IT index was up by 147 per cent while the healthcare index was up by 85 per cent. Nifty in the same period was up by only 42.6 per cent. The funds dedicated to these indices saw better performance and most of them saw their NAV doubling in this period. For example, Mirae Asset Healthcare Direct Growth saw a return of 126.6 per cent while DSP Healthcare Direct Growth too gained by 125.07 per cent in the same period. Their benchmark, S & P BSE Healthcare TRI, gained by as much as 97.13 per cent between the start of 2020 and the end of 2021.

Similar has been the case with IT-dedicated funds from the onset of 2020 until the conclusion of 2021 during which the information technology (IT) sector exhibited remarkable performance, delivering substantial returns. During this period, the IT index, represented by Nifty IT TRI, surged by an impressive 155.2 per cent. Equity funds specialising in the IT sector thrived, with many witnessing their net asset values (NAVs) soaring better than the index and providing returns of more than double. For instance, ICICI Pru Technology Fund.

Direct Growth shot up by an outstanding 202.88 per cent while ABSL Digital India Growth Direct wasn’t far behind, delivering a remarkable return of 175.93 per cent. These funds significantly outperformed their benchmark, the S & P BSE Teck TRI, which itself posted a solid gain of 121.5 per cent. This period highlighted the IT sector’s robust performance, offering investors potential for substantial growth.

Nevertheless, as the situation normalised globally and inflation started to resurrect its ugly head, we saw the fortunes of these sectors dwindling. Between January 2022 and May 2023, the performance landscape of key indices underwent a noticeable transformation. Frontline equity indices such as Nifty surged ahead and recorded 6 per cent gain during this period, thanks to the surge between April and May 2023, which helped it to post such gains. The healthcare and IT indices, however, saw a reversal in their performance. While the healthcare index saw a negative return of 9 per cent and the IT index posted a much worse picture and saw a fall of 25 per cent, both trailed behind Nifty’s performance. This has also impacted the performance of funds dedicated to these sectors.

Funds dedicated to the IT sector saw a steeper fall compared to healthcare. On an average, even the best of the funds fell by 17 per cent. The fund that saw the least downfall was Franklin India Technology Fund Direct Growth, which fell by 13.53 per cent between January 2022 and May 2023. Compared to this, there was a healthcare dedicated fund – SBI Healthcare Opportunities Direct Growth – that saw a positive return of 1.92 per cent. Nonetheless, overall the fall in the healthcare funds was 4.9 per cent. Most of the funds performed better than their benchmark, S & P BSE Healthcare TRI, which fell by 8.6 per cent in the same period. 

The graph clearly shows the movement of the equity indices based on these sectors. It portrays the three scenarios that we have discussed in the earlier paragraphs.

In the last couple of months, however, there has been a change in the course and we have once again seen these funds witnessing a boost in their NAVs. The million dollar question is whether this will be sustainable? We will try to explore the fundamental reasons to answer this question.
 

The Securities and Exchange Board of India (SEBI) defines sector funds in its circular dated October 6, 2017, titled ‘Categorisation and Rationalisation of Mutual Fund Schemes’, as follows:

Sectoral funds are investment schemes that allocate a minimum of 80 per cent of their assets to a specific sector of the economy, which can range from infrastructure and banking to technology or pharmaceuticals, among others. Because these funds concentrate on a single sector, they offer limited diversification, which in turn makes them inherently riskier.

It’s worth noting that sector funds might have some exposure to other sectors, but the majority of their assets – at least 80 per cent – are devoted to the chosen sector. Sector funds can be an attractive choice for investors who possess a strong belief in the prospects of a particular economic sector. However, it’s crucial to keep in mind that these funds tend to be more volatile when compared to diversified equity funds, mainly due to their concentrated focus on a specific sector. Therefore, before considering investments in sector funds, investors should thoroughly assess their risk tolerance and investment objectives.
 

Pharmaceuticals Remain Resilient

When we see the healthcare and the pharmaceutical sector, which encompasses diagnostic centres, hospitals, insurance firms, specialty chemical producers and API manufacturers, there has been a notable surge in interest from institutional investors. Diversified mutual funds, in particular, have amplified their involvement in the pharmaceutical and healthcare sector, marking a substantial shift in recent months. Most of these fund houses have significantly bolstered their weightage in this sector, transitioning from an underweight position to an overweight one compared to Nifty 200.
 

In some instances, funds have surged to nearly 600 basis points overweight, now accounting for a substantial 10 per cent of their portfolio weight. This weightage is a shade lower than the total weightage this sector has in Nifty 500. This shift in preference can be attributed to the pharmaceutical industry’s defensive nature. Amidst the prevailing uncertainties, the pharmaceutical sector stands as a resilient bastion. Regardless of global or domestic upheavals, the demand for pharmaceuticals remains relatively steadfast, making it a robust defensive play.

Furthermore, the pharmaceutical sector thrives on three distinct growth drivers: the domestic market, the United States and other international markets. While the US market previously posed challenges with pricing pressures, Indian pharmaceutical companies have lately experienced a significant turnaround, marked by noteworthy improvements in the US market conditions. The United States recently grappled with one of the most severe drug shortages in recent years. Several factors contributed to this issue, but the one key driver was stricter audits that uncovered lapses in quality standards among companies with extensive supply arrangements in the US.

These findings temporarily disrupted supplies, exacerbating drug shortages. Historically, such shortages have often led to substantial price increases, offering pharmaceutical companies the opportunity to raise prices for scarce drugs multiple times. Given the substantial dependence of the United States on medicines and intermediates supplied from India, domestic manufacturers and suppliers in India could potentially leverage this situation to their advantage. Simultaneously, those focusing on the Indian market are well-positioned to benefit from escalating domestic demand. In parallel, entities in the US generics sector are capitalising on drug shortages, mitigating price erosion and introducing high-margin medications. This collective optimism is readily reflected in the performance of indices. 

Year-to-date, the S & P BSE Healthcare index has surged impressively by 14 per cent, while the Nifty Pharma index has risen by approximately 11 per cent. In comparison, the Nifty 50 and the Sensex have recorded gains of around 7 per cent each in the year 2023 thus far. This outstanding performance underscores the promising and lucrative prospects within the pharmaceutical sector. Furthermore, the pharmaceutical and healthcare sector is poised for stronger earnings compared to the past 12 months. It appears feasible for the sector to achieve a normalised growth rate of 12-15 per cent in earnings over the next few years. This bodes positively for both the pharmaceutical and healthcare funds.

In summary, the pharmaceutical industry’s progress towards sustainability, innovation and global impact remains firmly on course. This makes it an interesting sector to observe as it continues to evolve and adjust to the ever-changing landscape of healthcare and technology. Therefore, our outlook for the pharmaceutical sector is optimistic at present.

Will IT Perform?

Over the past 17 months leading up to May 2023, it’s been a trying period for mutual fund investors with stakes in Indian IT stocks. Heavyweights such as Infosys have witnessed a decline of over 30 per cent from its peak, while other IT stocks have experienced similar drops. Wipro, for instance, has lost more than 40 per cent of its value during this time. The Nifty IT index itself has posted a decline of 25.12 per cent. Factors such as rising interest rates, geopolitical tensions and inflated valuations contributed to the technology sector’s downfall, impacting mutual funds investing in this space. For these sectoral tech funds it has been a challenging period.

However, the technology sector’s fortunes have begun to change in the last three months from June 2023 to August 2023. The Nifty IT index has risen by 10 per cent during this period, outperforming the broader Nifty index by 300 basis points. Many of the concerns that weighed it down have now subsided. Inflation has moderated, interest rates which were on the rise appear to have peaked and geopolitical issues are having lesser impact on the market. Additionally, there is fundamentally positive news driving this shift in investor sentiment.

Deal wins in the IT services sector have seen an uptick, especially in recent weeks, with mega deals on the rise. This suggests optimism for a recovery in the second half of FY24 and a strong FY25, supported by significant cost optimisation deals and improving macroeconomic conditions. These deals span various verticals and continents, with notable announcements in North America, such as Infosys securing a USD 2 billion deal to provide AI-powered digital entertainment globally.

While earnings for major IT companies in Q1FY24 remained subdued, experts anticipate a rebound in the coming quarters, driven by sustained margins and robust order books. From a valuation perspective, the sector is near its 10-year average PE multiple and the next phase of growth is expected to be fuelled by increased demand, client spending and advancements in technologies like automation, AI and cyber security. The weakness of the rupee is another factor benefiting the sector, leading to higher revenues for these companies for at least the next couple of quarters. However, despite Nifty, Sensex and most of the sectoral indices reaching new peaks, the IT index is still down by 20 per cent from its peak.

Strategy Tips for Investors

Pharmaceutical and IT are two of the largest and fastestgrowing sectors of the Indian economy. They are also considered as defensive sectors. Both these sectors are benefiting from strong tailwinds, such as an ageing population,increasing demand for healthcare services and the digital transformation of businesses both locally and globally. Nevertheless, it is recommended that conservative and new investors to avoid taking bets in sectoral and thematic funds. This is because sectors and themes go through cycles and inexperienced investors would find it difficult to continue with their investments during lean phases. 

Sector and thematic funds are only recommended for aggressive investors who are comfortable with taking higher risk and have the ability to stomach a lot of volatility. It is important to note that sector funds are riskier than diversified equity funds. This is because they are concentrated in a single sector, which means that they are more exposed to the risks associated with that sector. Playing an important role in investing in such funds is the timing. Investors need to make entry and exit in these schemes at appropriate times because of the cyclical nature of the sectors. Only well-informed and experienced investors can do that and many a times even they get the equation wrong.
 

Nonetheless, the sectors present opportunities for high-risk investors and those seeking tactical allocations. Sectors that struggled during the last few quarters, such as pharmaceutical and IT, are slowly becoming favourable now.

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