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Will investing in a pharma fund fetch good profits?

Avoid the temptation to invest in sectoral funds and opt for diversified equity funds instead, suggests Ashutosh Gupta

I want to know if investing in pharma funds will fetch good profits.
- R Visalam

I suggest that you avoid investing in pharma funds and rather continue to invest in more mainstream diversified equity funds. This is perhaps true for not just pharma funds but also for any sector fund for that matter. Because typically, you see a lot of retail investors start taking note of any sector fund after it has run up substantially. It's the tendency to chase the momentum that drives investors towards a particular sector fund, which can eventually lead to disappointment in many cases.

For instance, consider the case of pharma funds that delivered tremendous returns in 2020. As a sector, it was up around 60 per cent or more than that to be among the top performers of 2020. However, if you really break down the performance of the pharma sector into four calendar quarters of the year, you would notice that a bulk of those returns were delivered by pharmaceutical companies in the second quarter of the year, i.e., the quarter ending June. As per our estimates, the bulk of the money came into pharma funds in the third quarter of 2020, i.e., the quarter ending September.

So, while pharma funds delivered returns, a lot of investors did not make all those returns because they ended up investing after a bulk of that momentum had passed. In fact, in the last quarter of 2020 (December 2020), pharma stocks happened to be the bottom performers as many other sectors outperformed them by a fair margin.

This further reinforces the futility of trying to chase the momentum, because as I said, a lot of investors take note of a sector after it has already run up substantially. And typically every now and then, there would be one or the other sector which would appear as a top performer. But it is very difficult to time your entry and exit into a particular sector with precision to be able to benefit from these momentums that happen in different sectors at different points in time.

This is one side of the story. I would try and walk you through the other side of this picture. Look at diversified equity funds and the trends in their exposure to pharma as a sector. You would notice that through 2020, the exposure to pharma as a sector in diversified equity funds increased from about 5 per cent at the start to about 9 per cent over the year. Not only that, because of this, the ranking of pharma as a sector among the sectoral holdings of these funds increased from sixth-ranked sector to be among the top three. Also, if you notice, this rise in allocation among diversified equity funds happened fairly early in the year. Thus, these funds and their investors would have been able to benefit from the rise in the stocks of this sector. This further reinforces the fact that with diversified equity funds, you would have got adequate exposure to pharma as a sector in 2020 and therefore, you did not need to carve out a separate allocation by investing in funds that focus on the pharma sector only.

Thus, by and large, I'd say that for a vast majority of retail investors, sector funds are avoidable and they should continue to focus on diversified equity funds.

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