What you must keep in mind when investing in pharma stocks?

If the performance of the pharmaceutical sector excites you as an investor, you must also weigh the risks associated with it.

What you must keep in mind when investing in pharma stocks?

Celebrated Indian investor Rakesh Jhunjhunwala says he is “bullish” on India’s pharma sector, which in his view is undergoing a lot of churn. “India already is – and is going to remain – the pharma capital of the world,” he was quoted as saying. “It is not easy to build knowledge industries. I am bullish on… pharma.”

Career investors like Jhunjhunwala tend to take a long-term view on the pharma sector. And the general belief now is that this sector has entered a long-term bull market after years of being under pressure. If this excites you as an investor, you must also weigh the risks associated with this sector. 

Let us consider the various issues at stake.

A macro view

The pandemic has nudged the government to up its public healthcare spend. In the latest Union budget, healthcare allocation was 1118% more than that in the revised estimate.

The national spend on public healthcare is pegged at 2.5% of the GDP by 2025, up from 1.15% now. What’s more, there are plans to set up a nearly Rs 1 lakh crore ($1.3 billion) fund to help drug companies produce ingredients domestically by 2023.

Local manufacturing costs are one of the lowest in the world. India is also the largest supplier of generic medicines globally, accounting for 20%-22% of the global export volume, apart from 40% of generic demand of the US, and 25% of all medicines from the UK. India’s pharma sector is now expected to grow to $100 billion by 2025.

Analysts have also noted the expiry of patents worth $45 billion, where local drug makers have participation, over the next three years. “Of the nearly 70 drugs, we see 35 expiries as good for the sector on timely approval, launch, and market share execution,” says a BofA Securities sectoral note.

In other words, Indian pharma companies are going to make more generic drugs, an area that is its forte.

Related: Aftermath of COVID-19: Which sectors will struggle, which won’t

Multiple boosts

India’s pharmaceutical sector received boosts from several quarters in recent times. First, the pandemic disrupted China’s supply chains, boosting Indian exporters. Second, the US lifted import bans imposed on some Indian pharma companies for failing American quality standards at their plants.

Third, the US-China trade war shifted focus on India. Fourth, India’s pharma sector survived the domestic lockdown; Fitch Ratings said this was due to “adequate inventory”. Fifth, the pandemic pushed up demand for certain drugs.

All these factors combined to send the Nifty Pharma Index soaring 60% to its best annual returns since 2003 – making it the top sectoral performer in 2020.

BofA Securities, in a note, said it now expects price erosion in the US and USFDA regulatory risks – key sector headwinds – to stay low in 2021. Alongside rising exports, domestic sales are also expected to grow 9%-12% over the next five years.

Domestic financial institutions have now upped their y-o-y allocations for the pharma sector by 200% and foreign institutions by 120%.

Related: What investment decisions should you make during the global pandemic?

Pharma risks

Summing up the mood of the investing community, Elixir Equities founder-director Dipan Mehta wrote in The Economic Times: “The entire [Dalal] street is positive on pharma”. 

And why wouldn’t they be? Five pharma stocks more than doubled investments in one year, with Ajanta Pharma giving a return of 51.7%, the highest among the top 15 companies that yielded average returns of 27.89%. 

Yet, as MSS Securities director Ajit R Sanghvi writes in the same paper, the aggregate five-year return was lower than the one-year return in most cases.

What this means is it is once-in-a-lifetime pandemic that seems to have brought back the attractiveness of the pharma sector for now. However, viewed over the long term, the shine fades. As a Value Research analysis shows, pharma stocks were outperformed by several other sectors in the last quarter of 2020 (December 2020).

Analysts also warn that if you are looking at dabbling in the equity market, it could be risky unless you have sound knowledge of a particular sector.

This is particularly true of pharma; it is still a volatile sector, and higher returns are by no means a given. For instance, the threat of USFDA strictures will always remain; what if it is on the company you have invested in?

Besides, much of the budgetary increase in this year’s allocation for health is actually earmarked for COVID-19 vaccination and grants for water and sanitation; there was nothing for the pharma sector per se.

Related: 9 Work-from-home stocks that performed robustly during the pandemic

Last words

Of course, given the pharma sector’s current performance, its long-term potential thanks to the government’s future plans, and a leg-up from the US, it does not make sense to ignore it. In that case, you may consider investing 5%-10% of your portfolio in pharma funds, instead of putting your money directly in stocks. 

This has several advantages. First, these funds invest in pharma stocks across market capitalisation, increasing your chances of earning higher returns when compared to a benchmark index if the sector does well, as it is doing now. It also reduces your risk exposure.

Second, you avail of the services of professional fund managers. Third, it diversifies your portfolio. Also, if you take the SIP (systematic investment plan) route, you would spread your investment over a period. And finally, there are the tax breaks

However, do  bear in mind that the same risks remain. Also, satisfy yourself on the track record of the AMC concerned and the fund manager. Look at these 4 Smart money moves you should make in 2021.

Disclaimer: This article is intended for general information purposes only and should not be construed investment advice. You should separately obtain independent advice when making decisions in these areas.
 

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