Picking a pharma and healthcare fund post-Covid

Healthcare sector performance post-Covid has been remarkably different from what it was prior to the pandemic. BSE Healthcare index, which returned a tepid -2 per cent CAGR returns from 2016 to 2020, rebounded with 26 per cent CAGR returns since 2020 comfortably beating Nifty50’s 16 per cent CAGR. The sector valuation is hovering at all-time highs at 29 times one-year forward earnings.

The boost to performance in recent years and the existence of a large number of funds, each with different vintage, is a challenge in performance measurement in healthcare funds today.

To put all funds on a common base for comparison, we have measured the average of daily rolliing return over a one-three-five year frame, starting from 2020. This yields 1,125 days of data for funds, which have been in existence for a long time and a portion of the period for other funds. This is compared with the performance of the benchmark index (BSE Healthcare) to measure daily outperformance. For funds which have a shorter history, the outperformance is seen relative to the number of days the data is available for the specified time periods of one, three and five years.

Sector outlook

Despite the run-up in valuations, the healthcare sector does have a strong investment case.

Sectorally, hospitals and especially labs have gained prominence post-Covid. The universe of hospital stocks has increased from four-five to more than nine now, which is diverse in regions catered to, expansion plans that they have as well as their portfolio mix (mix of mature/new facilities). While sector valuations have continued to remain high, they are matched by the potential for earnings growth from expansion and improvement in margins. The pricing power and volume growth supported by lack of public healthcare infrasturcture is a structural positive for the sector as well. While labs are facing price-based competition, the scope for volume shift to organised diagnostic chains is supporting high valuations for this segment.

Pharma sector, which is the heavyweight in the index and the funds, is facing favourable US markets after a long time and is making the most with a strong suit of US generics. While the sector outlook is strong, the high valuations are an impediment and the fund manager’s role in stock selection in active funds is critical to outperformance.

Tracking the funds

As mentioned earlier, funds which have been around for a long time — and have seen three economic cycles — are compared with funds launched amid the current cycle, on the basis of performance of the last four years starting from 2020.

In the first group, SBI Healthcare and UTI Healthcare have 25 years of operations, while Nippon India Pharma Fund has 20 years. Tata India Pharma Fund is the youngest in this group with close to nine years of operations.

The year 2018-19 saw the emergence of five healthcare funds. While the pharma erosion cycle did not fully play out, the stocks did bottom out. This favoured the funds as only a year later, the healthcare rally gathered momentum.

On a five-year daily rolling return (RR) basis, the more recent funds outperformed with higher average five-year RR and 100 per cent beat on index on all days. But the outperformance could be due to the funds being measured for the last one year only and fewer observations. For example, DSP Healthcare returned 26 per cent average five-year CAGR with 100 per cent outperformance (beat the index all days), but data is available only 14 per cent of the time.

In funds with longer operating history, Tata Healthcare and Nippon Pharma funds also have 100 per cent outperformance but lower average return of around 15 per cent.

Even with three-year RR, the recent funds have only a 50 per cent data availability (600-700 days of data available). Being the most recent data, recency bias does creep in. Overall, Mirae Healthcare has a higher average of 23 per cent CAGR over three-year RR with only 86 per cent of days outperforming the index. Amongst the longer funds, Nippon Pharma has 20 per cent average in three-year RR and 98 per cent outperformance.

At the shorter analysis timeframe of one-year RR, all the funds have observations for all the days making for a standard base for measurement. DSP Healthcare Fund has the highest one-year RR average of 29 per cent, but with only 76 per cent of days outperforming the index. ICICI Pru Pharma and Nippon India Pharma have beaten the index regularly and the average return is near the peak as well with 28 and 27 per cent average one-year RR.

Amongst the wide choice available, we consider Nippon India Pharma Fund as having an edge in performance, despite the seemingly lower average as it has beaten the index at a higher frequency across one-year, three-year and five-year time horizons.