In the last one year, S&P BSE Healthcare fund has returned 62 per cent, bettering the broader BSE Sensex returns of 25 per cent. A strong revival in pharma and continued momentum in hospitals has ensured that the sector stands tall once again after the Covid rally of 2020-21. From the current vantage, stock picking from the sector should be a tougher ask compared with the past year. While structural changes can continue to drive incremental returns from the sector, some headwinds and rich valuations can temper outsized returns. For investors looking for long-term healthcare exposure, DSP Healthcare Fund, with the right mix of portfolio and strong return history, can be a suitable choice.

Sector outlook

The sector comprises of Pharmaceuticals, Hospitals and Diagnostic Labs primarily. Pharmaceutical industry is riding several tailwinds at the moment. The sector has re-discovered its US market potential. The large investments made, which were lying dormant, are now contributing to the companies’ return metrics as the plant approvals from US FDA have fallen in line. US generics, which used to depreciate 10-15 per cent every year, have recovered to mid-single-digit price decline per year. Both the legacy product base and new product flow were re-energised in the last year by lower erosion and plant approvals respectively. Until the next round of buyer consolidation in the US or new plant standards by FDA are issued, the current momentum in US markets can be expected to continue. India and other branded markets in emerging countries are also delivering strong growth, rounding off the sector’s strong show in the last one year. Many players in India have expanded their field force by 20-30 per cent in the last two years to regain space ceded to MNC pharma in the last decade.

Secondly, hospitals are finding structural tailwinds on both volume and pricing. According to Niti Aayog-2021, India will need 3 million more beds to reach the recommended three beds per 1,000 people. A large part of the gap is expected to be filled by the private sector, as government expenditure in healthcare remains below 0.5 per cent of GDP. Hospitals are now eyeing tier-II and below markets for expansion having explored metros and tier-I cities earlier. Pricing power also continues to remain with private players as buyer power is scattered amongst individuals and insurance and government account for less than half of the expenditure.

However, the sector is facing its share of risks too, starting with valuations. Nifty Pharma is now trading at 27 times one-year forward, which is a 30 per cent premium to five-year average. This implies that expectations have surpassed earnings of the next one year and need large opportunities to meet such expectations. Many pharma players are now making hay with gRevlimid launch in the US in FY23, which may reach a peak in FY26. The spike in product approvals recently from newly-approved plants may normalise even as buyer consolidation in the US is a lower threat to pricing.

Hospitals, on the other hand, are now facing a regulatory overhang from the Central government’s focus on standardised pricing for hospital procedures. How that transpires into action, especially when government is not the primary reimbursement source for hospitals, remains to be seen.

Net-net, the growth outlook is positive, and investors should stay exposed to healthcare trends in a developing economy. On the other hand, given the headwinds and valuations, an active fund could navigate the sector better, adjusting to these challenges.

Standout performance

There are 14 active sector funds for healthcare and pharma in India, of which three have more than 20 years of history. Four of the funds have been launched in the last one year alone, which indicates the interest in the segment. The fund in focus, DSP Healthcare, has close to five years of history.

Going by returns generated since each fund’s inception, DSP Healthcare leads the pack. The fund is the best performer among peers since inception over short and long timeframes (see charts). The daily average five-/three-/one-year returns (CAGR) since inception for the fund stands at 25.1/23.0/27.8 per cent. Over the same timeframe, S&P BSE Healthcare TRI, the benchmark, has returned 15.6/14.6/18.0 per cent in comparison. Thus, the fund beats the benchmark and its peers on return performance. Over any five-year period since inception, the minimum the fund has delivered is 23 per cent, including negative values.

Portfolio

The fund, as of February 2024, has a fairly balanced portfolio. Close to half of the fund is invested in pharmaceuticals with export focus and 17 per cent from domestic-focused Indian pharmaceutical companies. Hospitals, labs and medical retail account for 17 per cent of allocation, which also includes a domestic medtech company. The fund exposure to the US-based companies Illumina and Intuitive Surgicals is also focused on advanced medtech and is limited to 5 per cent of the portfolio.

The exposure to India, US generics, Indian healthcare is well balanced and supports the historical outperformance of the fund. Investors with a long-term outlook for healthcare can consider investing the fund.

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