Mutual funds: 23% returns in five-year period; should you invest in the surging healthcare funds? (2024)

The healthcare sector mutual funds have emerged as the third best equity category, with 59% average return in the past one-year period, marking a swift turnaround from losses in the previous 12 months. Though the recent positive performance may tempt investors eager to capitalise on this structural trend, there are various nuances in ‘healthcare’ funds that investors must consider before laying their bets on these sectoral offerings.

Decoding healthcare

Managing over Rs.23,000 crore in assets, there are 22 healthcare sector funds today. Eight of these are passively managed, which means that they track indices such as the Nifty Healthcare, BSE Healthcare, Nifty Pharma, and others. These cost 8-40 basis points in expense ratio.

Of the 14 actively managed funds, 10 (higher expense ratio of 50-100 bps) have at least one-year NAV track record, while the rest are relatively new. UTI Healthcare, SBI Healthcare Opportunities and Nippon India Pharma are among the oldest schemes.

Although labelled as healthcare funds, the majority (70-80%) of their assets are invested in pharmaceutical stocks. The remaining portion (15-20%) is allocated to healthcare-associated stocks, including hospitals, diagnostic chains, insurers, chemical companies, pharmacies, and others. Such companies operate under dynamics that differ from those of diversified or domestic pharma firms. Despite this, the equity market has re-rated them, following the pandemic. “Spirited stock market performance of healthcare companies (hospital and diagnostics) after Covid has resulted in higher allocation to the sector by pharma funds,” says Chandrachoodamani N.V., Senior Equity Analyst, PrimeInvestor. This segment can provide enhanced exposure to domestic businesses, including services, compared to the majority of pharmaceutical companies, which primarily focus on exports.

Don’t be blinded by high 1-year returns

The stock universe of healthcare funds consists of about 70 stocks (excluding overseas firms), with roughly 50% being large caps and the remaining categorised as mid and small caps. Market capitalisation distribution closely mirrors that of the BSE Healthcare index. However, certain newly launched schemes, such as Quant Healthcare and WhiteOak Capital Pharma and Healthcare, exhibit higher exposure to mid and small caps.

Across actively managed healthcare funds, top holdings (in % terms) are Sun Pharma, Cipla, Apollo Hospitals, Lupin, Max Healthcare, Dr Reddy’s Laboratories, Aurobindo Pharma, Suven Pharma, KIMS, Divi’s, Rainbow Children’s Medicare, Gland Pharma, Abbott India and Fortis Healthcare. Most funds have 58-70% of their holdings in 10 stocks. While investing in sectoral funds, the investor wants to maximise the potential of the sector by allocating higher amounts to the best players in the sectors. “Hence, it’s fine for funds to have concentration of funds in the top 10 stocks,” points out Anand K. Rathi, Co-Founder, Mira Money.

Tracking returns

The recent performance surge has lifted the category scorecard of healthcare funds, with an average return of 59% over a one-year period, a compounded annual growth rate (CAGR) of 18% over a three-year period, and 23% CAGR over a five-year period. This is as per the latest data from Value Research.

However, investors should note that, historically, healthcare has been a ‘defensive’ play, and tends to do well during market corrections. Data indicates that the BSE Healthcare index managed to mitigate losses during challenging years, such as 2008 and 2011. Further, if we divide the last 10 years of the BSE Healthcare index into five phases, it’s observed that healthcare funds underperformed during three rising periods, but outperformed during the two declining phases. “Instead of looking at just returns, healthcare portfolios can provide a low-correlated return stream compared with the broader markets. This can potentially boost the overall risk-adjusted return,” says financial planner Karthik Jha.

A few funds, such as DSP Healthcare and ICICI Prudential Pharma Healthcare and Diagnostics (P.H.D), use the overseas route for diversification. Overseas stocks include the likes of Globus Medical, TARA, Abbott Labs, Illumina, Viatris, Intuitive Surgical and Lonza. “For a fund aiming to invest in the sector and invest in companies best positioned to grow with the current opportunity cycle, it makes sense to do the same in a geography-agnostic manner,” says Nirav Karkera, Head, Research, Fisdom.

In India, the healthcare sector has been trading around long-term averages in terms of valuations. “We turned bullish on the entire pharma and healthcare space in January 2024. The sectoral funds are a good addition to the tactical portfolio allocation of MF investors who are looking to enhance returns through concentrated bets,” says Gautam Kalia, Head, Super Investor, Sharekhan by BNP Paribas.

Supported by a decent earnings outlook, driven by factors such as a long growth runway, healthcare funds have the potential to perform well if the markets continue to rise, while also providing a cushion against any potential declines. Analysts see an uptrend in this space due to the launch of new products in the US and India markets, loss of exclusivity opportunity across regions for generic players, priority to healthcare spend by the Indian customer, and cash-rich position of many firms.