Mutual Fund Category Analysis Pharma Sector Funds

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1 November 26, 2014 Mutual Fund Category Analysis Pharma Sector Funds Key Facts: What are they? Pharma Sector funds are equity oriented schemes investing predominantly in the pharmaceutical stocks. Pharma Category: There are 3 schemes such as Reliance Pharma Fund, SBI Pharma Fund and UTI-Pharma & Healthcare Fund coming under this Pharma category. Pharma sector is defensive sector basically as the sector is least impacted by market volatility given their low capital intensive capabilities. However over the past few years, it has changed its character and now it rises in line with the market but falls less. Suitability: These are suited for high risk profile investors who are well-versed with the stock market and understand the sectors and their moves. Indian pharmaceutical industry: The Indian pharmaceutical industry plays a vital role in promoting and sustaining development in the field of global medicine. India s healthcare industry is well set for rapid expansion due to the presence of low cost manufacturing facilities, educated and skilled manpower and cheap labor force. The Indian Pharma sector has been on a strong growth trajectory as the sector offers good growth visibility and strong cash flows with low capital intensity. Indian pharmaceutical industry is valued at USD 12 billion in 2013 and is expected to grow to USD 55 billion by Globally, India ranks 3rd in terms of volume and 10th in terms of value. Sector Funds: Equity Sector funds are riskier categories among the equity oriented mutual funds, as they follow concentrated investment approach of investing in a particular sector. The performance of the sector funds are cyclical in nature and sensitive to change in their respective sectors. They have managed to deliver good returns in times when their respective sectors or industries performed well. Performance: The Pharma sector category showed better performance over periods in comparison to the other equity oriented categories. Performance based on rolling returns calculated for last 7 years shows the outstanding performance of the pharma category against the other equity oriented categories in all the time frames (see the table below in page no. 5). Considering the performance during various market cycles, the category showed its best performance during market downturns as it contained well the level of losing the money in comparison to the other equity categories. The performance of the category during the volatile periods also notable. Meanwhile, the performance during the bull market also decent. Portfolio: The schemes from the pharma category mostly follow the multi-cap investment strategy of investing in the stocks in pharma sector across the market capitalization. This dynamic asset allocation strategy enables the schemes investing in all important segments of the pharmaceutical industry including Domestic Business, International and CRAMS deep value as well as high growth pharma businesses. All the schemes prefer to hold maximum assets in largecaps stocks. However, Reliance Pharma Fund saw allocated close to 41% of assets in mid-cap stocks. Sun Pharma, Lupin Ltd, Divis Laboratories Ltd, Dr Reddys Lab and Cadila Healthcare Ltd are the top 5 preferred stocks by the category as of Oct The Turnover ratio has been kept ranging 16-49%. Reliance Pharma Fund and SBI Pharma Fund showed better performance based on both rolling returns as well as trailing returns and during various market cycles.

2 Equity Sector Funds: Sector funds are high risk high return funds. They are more risky than diversified equity oriented funds. Diversified equity funds mitigate the downside risk by diversifying their portfolios across sectors, while the sector funds are exposed to higher risk as they are narrow in terms of asset allocation on particular sector. Further, diversified equity funds have the leeway not only to pick the best performing and growth sectors but also to remove poor performing sectors. On the other hand, sector funds invest only in the sectors as mandated and adhere with the objective irrespective of any market conditions. Even though sector funds have a potential to fetch better returns compared to other equity oriented funds based on developments in the sectors, one cannot expect consistent returns over periods since their investment strategy hovers within a limited sphere. The performance of the sector funds moves in cycles. Every cycle will have a new out-performer and an under performer. For example, the Information Technology sector was at peak while compared to other sectors during the year But it was seen at the bottom during The sector came to the top slot in 2009 again. Likewise, was the best performing period for infrastructure industry. They turned bottom performer for the next four years. The banking sectors outperformed during 2009 but underperformed in Hence, the performance of these funds is linked to the fortunes of the sectors. The funds do well if the respective sectors perform well. Interestingly, some of sector funds over the long run outperform even the diversified equity funds. The below chart proves this fact as the sector categories such as FMCG, Pharma and Banking delivered better returns for the three and five year time frames than diversified equity category. Pharma Sector outlook: Phama sector is defensive sector basically as the sector is least impacted by market volatility given their low capital intensive capabilities. In India, the pharmaceuticals market has its unique characteristics of branded generics domination, prominent local players and their dominant position driven by formulation development capabilities and low price level due to intense competition which present their own opportunities and challenges. The Indian Pharma sector has been on a strong growth trajectory as the sector offers good growth visibility and strong cash flows with low capital intensity. There are 3 major platforms of growth for the Indian pharmaceuticals market viz, Domestic Market, Exports and CRAMS. The growth of the Indian pharmaceuticals market is primarily driven by exports as it exports drugs to more than 200 countries and vaccines and biopharmaceutical products to about 151 countries. Indian pharmaceutical industry is valued at USD 12 billion in 2013 and is expected to grow to USD 55 billion by Globally, India ranks 3rd in terms of volume and 10th in terms of value.

3 However, there are many daunting challenges that Indian pharma sector faces like different type of regulatory headwind, Drug Prices Control, declining global generic market opportunity, litigation etc. Expert believe that the Indian Pharmaceutical Market would grow at a compounded annual growth rate of 12-14% majorly driven by rising incomes, enhanced medical infrastructure, rise in the prevalence and treatment of chronic diseases, greater health insurance coverage, launches of patented products and new market creation. Further, Indian pharmaceutical companies have an opportunity to capitalise the going off patent and gain a greater share of the growing generics market. During , about USD 92 billion worth of patented drugs are expected to go off-patent in the USA. The following is the chart showing the deployment of funds by the whole equity MF industry among sectors. Investment in pharma stocks has been consistent over periods. Exposure to Sectors by the Mutual Fund Industry (Top 5 sectors):

4 Pharma Sector Funds Vs. Other Equity Oriented categories: Equity Oriented Categories Performance (based on Rolling Returns): Scheme Name 6 Month Absolute 1 Year 3 Year 5 Year Pharma category Equity Diversified category Banking category FMCG category Infotech category Infrastructure category Note: NAV values are as of Nov 17, Top 2 performers are highlighted by yellow. Returns are rolling calculated from the last 7 years NAV history. Pharma Sector Funds Vs. Other Equity categories in various cycles: Risk Parameters: Standard Deviation: The above chart shows the Pharma sector category s better performance especially during equity market fall cushioning the downturn well compared to other equity oriented categories. The defensive nature helped the category to contain the losses during bear runs. The category showed better performance in volatile period as well. The performance of the category during bull runs also comparatively notable. As seen in the above chart, the lowest Standard Deviation (calculated based on the daily returns from the last 3 years NAV data) to the Pharma category makes the category lower risky in comparison to the other equity oriented categories.

5 Allocation to Sectors by the Pharma Category: Top 10 Stocks held by the Pharma sector category: Performance of schemes from Pharma category: Scheme Name Scheme Age (Yrs) Benchmark Latest Corpus (Rs Crs) Expense Ratio (%) 6 Month Absolute Trailing Returns (%) Rolling Returns (%) Reliance Pharma Fund (G) BSE Healthcare SBI Pharma Fund (G) BSE Healthcare UTI-Pharma & Healthcare Fund (G) CNX Pharma Benchmark: BSE Healthcare Index CNX Pharma Index Nifty Index FMCG Category Infotech Category Equity Diversified Category Pharma Category Year 3 Year 5 Year 7 Year 6 Month Absolute Note: NAV values are as of Nov 17, Rolling Returns are calculated from the last 7 years NAV history. Standard Deviation and Tracking Error are calculated from last 3 years data 1 Year 3 Year 5 Year Standard Deviation

6 Performance and Portfolio composition of the schemes from the Pharma category: Reliance Pharma Fund (G) Performance of the schemes on various time frames (Point to point returns): Performance of the schemes during various cycles: As far as Rolling Returns are concerned, Reliance Pharma fund outperformed the other two schemes. However, SBI Pharma Fund scores over others in terms of trailing returns are concerned. Reliance Pharma outperformed its benchmark and categories almost all the periods. Portfolio Sector Allocation: Reliance Pharma saw appreciation more during bull markets but at the same time depreciated lesser during bear markets compared to the benchmarks. The inhabitant defensive nature helped the category to contain well during beer runs. In the recent Bull Run, Reliance Pharma posted equivalent returns in comparison to Equity Diversified category. Market Capitalization: Increased exposure seen in the Pharmaceuticals - Indian - Bulk Drugs & Formulation sectors in the recent periods. Reliance Pharma maintained considerable exposures into mid-cap schemes in comparison to other two peer schemes. The scheme has gradually increased exposures into mid-cap stocks over period. Over the last one year period, an average of 40% of assets are kept in to mid-cap spectrum.

7 SBI Pharma Fund (G) Performance of the schemes on various time frames (Point to point returns): Performance of the schemes during various cycles: As far as trailing returns are concerned, SBI Pharma showed notable performance as it outperformed its peers, benchmarks and Equity Diversified category with notable margin (see the above chart). However, rolling returns wise, Reliance Pharma posted better returns. Given in the recent mid-cap rally, SBI Pharma posted higher returns than Reliance Pharma despite the former exposed lesser into mid-cap stocks than the latter. Portfolio Sector Allocation: SBI Pharma managed to perform well in all the market cycles viz. bull, bear and volatile periods. During volatile equity markets, the scheme performed well compared to its peers. During market downturns it contained its loss well. The defensive nature helped the category to contain well during beer runs. The performance of the scheme in the recent Bull Run has been notable. Market Capitalization: The scheme mostly stayed invested in Indian Pharmaceuticals companies. Less than 2% of the assets are invested in multinational Pharmaceuticals companies seeing in all the periods. Among the peers, SBI Pharma held the most into large-cap stocks. However, the considerable portion into mid and small cap stocks helped the scheme to post comparatively better returns during market rallies. The latest portfolio shows close to 19% of assets kept in mid-cap stocks.

8 UTI-Pharma & Healthcare Fund (G) Performance of the schemes on various time frames (Point to point returns): Performance of the schemes during various cycles: UTI-Pharma & Healthcare posted above average returns compared to other equity oriented categories. However, the scheme saw posted under performance against its other two peers during all the time frames as far as trailing returns are concerned. Considering the rolling returns, over the longer run, the schemes posted similar returns compared to its peers. Portfolio Sector Allocation: The performance of UTI-Pharma & Healthcare fund has been commendable during market downturns as it depreciated the least among the peers and benchmarks. However, it posted decent but underperformed returns against its peers during bull runs that were seen in the last seven years period. Market Capitalization: Like, SBI Pharma, UTI-Pharma & Healthcare also invested maximum in Indian Pharmaceuticals companies. Decreased exposure into multinational Pharmaceuticals companies seen over the last one year period. The latest data show that close to 5% of the assets kept in these stocks. Almost 3/4th of assets kept in large-cap stocks. The scheme allocated more than 30% of assets into mid-cap stocks before 2 years. It seems that the tilting towards the large-cap stocks made the scheme to deliver lower returns compared to its peers in the recent periods.

9 Top 10 stocks and their weightage in the relative Indices (data as of 31 Oct 2014): Company Name Reliance Pharma SBI Pharma UTI-Pharma & HC Nifty BSE Healthcare CNX Pharma Sun Pharmaceuticals Industries Ltd Dr Reddys Laboratories Ltd Lupin Ltd Cipla Ltd Divis Laboratories Ltd Ranbaxy Laboratories Ltd Aurobindo Pharma Ltd Biocon Ltd Glenmark Pharmaceuticals Ltd Wyeth Ltd 2.15 Indoco Remedies Ltd Strides Arcolab Ltd Ipca Laboratories Ltd Cadila Healthcare Ltd Natco Pharma Ltd Sanofi India Ltd Torrent Pharmaceuticals Ltd Abbott India Ltd Investment Details: Minimum Investment for Lumpsum: Rs. 5,000 and for SIP Reliance Pharma Rs. 100, UTI Pharma & Healthcare- Rs. 500 and SBI Pharma Rs. 1,500. Exit Load: For Reliance Pharama 1% for redemption within 365 days, for UTI Pharma & Healthcare 1% for redemption within 548 days and nil for SBI Pharma. Total corpus of the category stood as on Oct 2014 at Rs. 1,650 crore. Analyst: Dhuraivel Gunasekaran Source: NAVIndia & ACEMF Tel: (022) Fax: (022) Corporate Office HDFC securities Limited, I Think Techno Campus, Building - B, "Alpha", Office Floor 8, Near Kanjurmarg Station, Opp. Crompton Greaves, Kanjurmarg (East), Mumbai Phone: (022) Fax: (022) Website: hdfcsecretailresearch@hdfcsec.com Disclaimer: Mutual Funds investments are subject to risk. Past performance is no guarantee for future performance This document has been prepared by HDFC Securities Limited and is meant for sole use by the recipient and not for circulation. This document is not to be reported or copied or made available to others. It should not be considered to be taken as an offer to sell or a solicitation to buy any security. The information contained herein is from sources believed reliable. We do not represent that it is accurate or complete and it should not be relied upon as such. We may have from time to time positions or options on, and buy and sell securities referred to herein. We may from time to time solicit from, or perform investment banking, or other services for, any company mentioned in this document. This report is intended for non-institutional Clients This report has been prepared by the Retail Research team of HDFC Securities Ltd. The views, opinions, estimates, ratings, target price, entry prices and/or other parameters mentioned in this document may or may not match or may be contrary with those of the other Research teams (Institutional, PCG) of HDFC Securities Ltd.