Pharma Funds: Bitter Returns

If you have been visiting Personalfn over the years, you know that we have been very consistent in our view on sector funds. We have always recommended that investors avoid such funds, unless they are prepared to take on very high risk. Recently, we cautioned investors regarding going overboard on their exposure to infrastructure funds. Many felt that we were wrong in our assessment. Well, we are not surprised on hearing this!

Every time there is euphoria surrounding a sector in general or a stock, it is always difficult to get through to investors. The noise is deafening and the voice of reason almost mute. So overtaken are investors with the lure of making easy money that they refuse to be reasonable. They wish to ride the opportunity till the end. And more often than not this is what happens; they continue to remain invested till all the hype surrounding the sector/stock has peaked and subsequently waned. In the process, you, the investor, probably make a return that does not compensate you for the commensurate risk.

Our note, Infrastructure Funds: Hot Property, highlighted the fact that investors have taken irrationally high exposure to the infrastructure sector without paying much heed to risk. In current times, since it pays to take risk, an investor almost seems justified in pushing the limits.

But, have sector funds as a category delivered over the long-term?

In case of sector funds, we define long-term as 5-Yrs. That’s the tenure we think one should be invested for, if at all. To understand past performance of sector funds, we had very limited choice. Among the various types of funds, the Technology Funds per se have been there the longest. However, post the meltdown in year 2000, most such funds changed their mandate. The current favourites, the infrastructure funds, do not have much of a track record.

That leaves us with pharma sector funds, which have been there for quite some time.

We compared the performance of the pharma funds, which have been in existence for the last five years, with the BSE Sensex and a popular diversified equity fund – HDFC Equity. The performance is plotted in the Chart below.

What is apparent from the chart is that pharma funds have been a disappointment. Indeed, intermittently in this 5-Yr period, pharma funds caught the fancy of investors. But what remains is that if you were unable to time entry and exit into the fund, and were simply invested over this period, the returns were not out of the ordinary. You simply took more risk but were not compensated for it. You would have been much better in the Index, or better still, in an actively managed diversified equity fund like HDFC Equity.

• Read Equitymaster’s Report on the Pharma Sector. Click here.

What is to be noted here is that HDFC Equity Fund does own pharma stocks; however, its fund manager is not compelled to own pharma stocks when he does not find value in them. And that’s the one big disadvantage in a sector fund – the fund manager will have to remain invested in a sector even if he is no longer comfortable with the prospects.

As in our article on infrastructure funds, we are not making a call whether the pharma sector is poised to do well or not. What we are recommending is that you should avoid investing in sector funds. But if you must, then ensure your exposure is no more than 5% - 10% of your portfolio.