Will Healthcare mutual funds survive beyond Covid-19? Chirag Dagli of DSP Mutual Fund says yes

Healthcare funds are on a roll since the COVID-19 pandemic struck. On the back of 55-60 percent annual returns, inflows into these funds are rising too. Chirag Dagli, who manages the DSP Healthcare Fund, feels that while such dizzy returns are not sustainable, there is some steam left still. Unlike in the past, the healthcare domain now has multiple sub-segments, each of which has unique growth levers, explains Dagli. As a result, the sector is less cyclical and more stable. In a conversation with Vatsala Kamat, he talks about his unique investment approach.

Given the short history of DSP Healthcare Fund (launched in November 2018), do you think your good performance so far has largely been due to the onset of the COVID-19 pandemic?

While the pandemic gave a boost to the portfolio, the upswing in the pharmaceutical and healthcare universe started earlier, towards the end of the year 2019. Large companies were at the end of the capital expenditure (capex) cycle and research & development (R&D) spends. We observed a two-and-a-half times jump in cumulative capex and research and development (R&D) spends in generic pharmaceuticals between FY16-20, versus FY11-15. This had led to a derating of the sector and fall in return ratios.

The payback period, which usually comes with a lag, after all regulatory approvals, started in 2020. From then till now, which is a little over a year, there has been outperformance. But over a five-year period, the healthcare sector has underperformed the broader markets. So, I think there’s still some catching up to do.

Not all companies benefited from COVID-19, did they? How did you restructure your portfolio?

The pandemic was unprecedented. It was a learning curve for everyone. Investors believed that most pharmaceutical companies would benefit from COVID-19; share prices of a few firms went up disproportionately.

There was a lot of volatility. But if a company surprised with unstainable revenue or profit margins and the markets rewarded the stock, we took some money off the table, and lowered the portfolio exposure to it.

The pandemic also threw lot of challenges. Demand for hospital beds and medical facilities did not help earnings growth, as many other non-COVID surgeries and treatments got cancelled, given that more beds had to be allotted for the pandemic care.

Also, companies that gained from the vaccines were mainly unlisted firms. So, we did not really restructure the portfolio, based only on the pandemic.

Healthcare mutual funds got a lot money from investors last month. Would managing increased inflows be a problem?

Yes, flows into healthcare funds are rising after the recent outperformance. But the 60-65 percent annual return clocked in the past is not sustainable.

However, investors must realise that healthcare is not a cyclical sector like banking or metals. Healthcare sector is a very diverse. About 25 percent of our fund is invested in the domestic formulations business. A fourth is in export formulations and 15 percent in hospitals. Some exposure is present in international medical equipment companies or even pathology firms.

Each of these sub-sectors behave differently. Healthcare is a secular theme. The sector’s performance is not yet close to the FY15-16 peak, although valuations are high. But this does not mean that there could be a repeat of last year’s performance.

Also, it doesn’t mean that once the COVID-19 pandemic ends, the healthcare sector would stop performing. Our fund has exposure to companies in the medical equipment sector and even hospitals, which have taken a big beating last year because of the lockdown. This segment has companies catering to robotic surgery, implants, etc., which will benefit with the economy opening up. So, a part of this fund’s portfolio will benefit from the economy opening up and business normalizing, as well.

How are today’s healthcare mutual fund schemes different from pharmaceutical schemes launched two decades ago?

A decade ago, there were only a few pharmaceutical companies. Today, there are more companies in the listed universe. The sector now includes hospitals, equipment and pathology companies. Funds can also invest in international companies, thanks to technology making communication with any part of the world, a breeze. There are reports of medical retail stores, pharmacies coming into the listed domain. Today, the healthcare sector is more mature and diverse.

How do you think a lay investor should take exposure to healthcare company stocks?

Healthcare sector constitutes around 5-6 percent of benchmark indices on the NSE or BSE. These companies would be largely frontline generic industry firms. But they are exposed to US-based regulatory risks. Even an inspection notice for a company by the US healthcare regulator is enough to send its share price down.

Hence, an 8-10 percent exposure to health care sector fund, within your overall equity funds portfolio, is good enough.

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