Motilal Oswal has launched a couple of index funds targeting sectors in Nifty Mid-Small Cap index. The NFO tracking Nifty Mid-Small Cap Healthcare index is open till November 6. The index has delivered better returns in the past compared to mid-cap or healthcare segments owing to sub-sector relevant drivers. But coming at a time when market wide correction is ongoing, investors have to be aware of the specific risks as well. We recommend, investors seeking long-term growth from healthcare segment can invest a minor portion of their portfolio in the index fund but built up gradually.

Index construction and returns

The lesser-known index is composed of healthcare stocks forming part of the Nifty Mid-Small Cap index of 400 constituents. The 30-stock index hence avoids the top-tier stocks (by market cap) in healthcare universe, instead focusing on the mid-tier universe. As on September 30, Max Healthcare, Lupin, Aurobindo Pharma, Fortis and Alkem are the top five stocks in the index with weights of 13-10-7-6-6 per cent, respectively. The 30-stock composition overall has labs, hospitals and allied sector representation alongside pharma.

The index has outperformed other relevant indices. As can be seen in the table, Nifty Mid-Small Healthcare index has outperformed all others in five-year average rolling returns in the last 10 years, and marginally trails Nifty Mid-cap 100 in three- and one-year rolling returns. More importantly, the index has handsomely beaten Nifty Pharma in the period despite avoiding the sector bellwethers.

Sector drivers

The primary driver is the sector construction, which is more diversified. The top five of the index account for 42 per cent of the weight compared to 58 per cent for Nifty Healthcare. Apart from diversification benefits, this also allows for hospitals, labs, medical devices and healthcare services a higher weight in index formation which have a diversified growth direction to pharma and higher scope of growth owing to organised market penetration.

The pharma composition of the index is also markedly different. This index focusing on mid-tier companies, inadvertently places its bets on India focused pharma companies. Abbott India, Alkem, Ajanta Pharma, IPCA Labs, JB Chemicals, Glaxosmithkline Pharmaceuticals and Procter & Gamble Health are part of the index composition. India focus pharma play has a stronger and stickier growth path as the portfolio is largely branded compared to plain generic portfolios of the US and export-focused companies that are part of the top-tier. As can be seen, despite being mid-tier, the pharma companies in the index have built strong brands in India, which provides a strong entry barrier. The index fund can also be a proxy to India focus pharma and healthcare.

Risks

While structurally the index has strong growth drivers, the short-term prospects are volatile, stemming from the sector concentration risks and mid-cap focus. Nifty Mid-cap 100 has declined 5 per cent in the last two weeks compared to Nifty 50’s 3 per cent decline. Considering the outperformance of the small- and mid-cap stocks in the last three years, over the broader index, the ongoing correction can have a higher impact on the mid-tier stocks.

The entry barrier acts as a strength against new entrants, but the top-tier pharma companies are refocusing in the domestic markets. The outperformance of the mid-cap pharma stocks in the last five years was on account of export focused stocks facing headwinds in the US and Europe, which is only beginning to thaw. Despite the recovery, the top-tier pharma stocks have invested heavily in Indian sales, domestic-focused portfolios, and in-licensing opportunities. This will be a headwind for the sector, especially since their diversification to the US has been lacklustre, and relying on the same generic portfolios.

With scope to tap into domestic growth prospects, the long-term drivers are positive for the sector. But the current market movement and the rally of the past three years are a potential headwind. The index trades at trailing PE of 53 times compared to 45 for Nifty Mid-cap 100 or 24 for Nifty 50 pointing to the potential buildup in the sector post-Covid.

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