Mutual funds operate on the premise that by investing in several stocks belonging to various sectors the fund manager is in a position to offer better risk adjusted returns using diversification. The very fact that the fund manager can move across sectors gives him the freedom and the flexibility to pick those stocks that best suit his portfolio.

This is where sector funds differ from other mutual funds. The fund manager's choice is restricted to various stocks within the same sector, thus making sector funds a contradiction to the concept. The fund's limited diversification makes it a high risk-high return proposition as experienced by tech fund investors in 2000.

In the recent past pharma funds have captured investors imagination. The table below shows returns offered by leading pharma funds.

Pharma Funds: High risk-High return

Pharma Funds	NAV (Rs)	A.U.M.(Rs m)	1-Mth	6-Mth	1-Yr	3-Yr	Incep.	SD
MAGNUM PHARMA	12.89	255.40	2.1%	76.5%	65.1%	14.7%	8.5%	6.28%
UTI SEC-PHARMA	14.68	760.00	0.9%	55.7%	41.8%	15.0%	5.4%	5.53%
FRANKLIN I PHARMA G	13.42	551.30	0.5%	63.0%	46.9%	11.8%	8.2%	5.84%

(NAVs as on September 30, 2003, Growth over one year is compounded annualised)
(Assets under management as August 31, 2003) (Standard deviation indicates by how much the values have deviated from the mean of the values. It measures by how much the investor has diverged from the mean return either upwards or downwards. It highlights the element of risk associated with the fund.)

While the interest in pharma funds is not wholly unjustified, the interesting factor is the sudden spurt of interest in such schemes. The attractiveness of the sector from an investment perspective is clearly apparent. Following are some of the key investment arguments (for more please visit www.equitymaster.com)

1. A large number of MNC pharma companies in India (including Glaxo and Pfizer), stand to benefit significantly post 2005 when India starts to recognize product patents.

   The recent price upswing can be attributed to the strategy adopted by some companies wherein they have chosen to aggressively launch new products from their parent company's product portfolio.
    

2. As far as the sector as a whole is concerned, a couple of opportunities stand out
   With the cost advantage that India enjoys in manufacturing becoming very apparent, it is anticipated that foreign companies could outsource manufacturing of pharmaceutical products to India. This could result in a huge windfall to domestic companies, several of which already have manufacturing facilities that are approved by organizations such as the US FDA.

   Indian arms of MNCs are increasingly being considered as outsourced bases for manufacturing and research activities.
    

3. Then there is the excitement surrounding the research initiative of domestic pharmaceutical companies. While some are working on new molecules altogether (high risk high return), others have chosen to improvise on existing products. Already companies like Ranbaxy and Dr. Reddy have met with success. Outsourcing R&D activities is likely to benefit mid-cap and small companies as well.

Pharma funds: Recent history

Pharma Funds	NAV (Rs)	6-Mth
MAGNUM PHARMA	12.89	76.5%
UTI SEC-PHARMA	14.68	55.7%
FRANKLIN I PHARMA G	13.42	63.0%

(NAVs as on September 30, 2003)

The returns in the short-term particularly the last six months have been substantially rewarding to say the least. Growth rates in the range of 63.0% to 76.5% have been recorded in the 6-month period.

However the long term period portrays a completely different picture. The growth rates in this period (3-year) have been mundane. An investor who has stayed invested since inception would find his returns (5.4% to 8.5%) fairly unattractive vis-à-vis the investor who entered the scheme a year (46.9% to 65.1%) ago.

The impressive returns offered by Magnum Pharma should be seen in conjunction with its Standard deviation figures. Investors should be aware of the risk they undertake in terms of volatility in returns. On the other hand UTI Pharma looks like a relatively safer bet with lower standard deviation figures, yet attractive returns.

Sector-specific funds mirror the risk-return trade off in complete totality. Only individuals with a high appetite for risk should invest in these funds. Remember the proverb which went Don't put all your eggs in the same basket. That is precisely what you do when you invest in sector specific funds.

 

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