Why is it that some sector funds outperform while others deliver miserable returns? The answer lies largely in stock selection. If the fund manager chooses stocks that are rising, this will obviously mean that the fund performs well and vice versa. Stocks in some sectors are cyclical, so the fund manager must not only choose stocks wisely, he will have to be able to time the market well.But cyclicality alone cannot explain the poor performance of stocks in the pharmaceuticals and health-care sector. From being one of the most promising sectors, pharma is now shunned by investors and fund managers alike. That's why, in spite of a 50% rise in the Sensex, the BSE Healthcare Index delivered an abysmally low return of 16%.
WIN SOME, LOSE SOME
"Companies in the pharmaceuticals sector were going through a rough patch. Increased competition in the generics space, pricing pressure, rupee appreciation and high R&D costs muted growth," says Sarabjit Nangra, VP Research, Angel Broking. And this means pharma sector funds have also been performing poorly, with the category average return at 21% in the past one year. The assets under management (AUM) of the five pharma funds fell by over 22% between September 2006 and September 2007.
This is not to say that all pharma sector stocks have been poor performers. There have been winners and there have been outperforming pharma funds as well. Reliance Pharma, the top performing pharma fund, leads by a significant 40 percentage points. Its holdings include firms such as Ankur Drugs, Divis Labs and FDC. These have only recently moved into the large-cap or emerging large-cap space from small- and mid-cap stocks.
Strangely, some of the industry biggies, including Dr Reddy's and Pfizer, were attractive to only a few funds. Companies like Divis Labs have returned 200% over the past one year compared to a modest 6% gain by Ranbaxy, whereas Dr Reddy's and Cipla have delivered negative returns of 10% and 16%, respectively. One reason is that the heavyweights have more than 60% of their revenues coming from the generic drugs business, which has witnessed increasing competition and pricing pressure. International markets too posed challenges for Indian generics companies.
"The currency appreciation has impacted companies that have exports in excess of 50% of their revenues," says Sailesh Bhan, fund manager, Reliance Pharma Fund. Pricing pressure in the UK and health-care reforms in Germany and France all impacted revenues of companies like Dr Reddy's, Ranbaxy and Wockhardt, which have a significant presence in these countries.
Although generic drugs have always been the main earner for Indian pharmaceutical companies, the introduction of the Patents Law in the country has led to a paradigm shift in many business models. Pharma companies that planned for this shift began to look at the more profitable business areas within the sector. Businesses like contract research and manufacturing services or CRAMS (see box) started doing well from 2005, when the CRAMS market grew by 40%. Other profitable areas were new drug discoveries, research and development alliances, co-marketing alliances, etc. This is where companies like Divis Lab or Dishman Pharma score over the others.