Your Questions Answered: What are the best index funds for investing in the pharmaceutical sector?

Q. I am a senior scientist working with a government laboratory in Hyderabad, my wife is a professor with a government university in Hyderabad. We have been investing in large-cap mutual funds for the past 7 years. We want to diversify our portfolio and invest in sectoral mutual funds. We want to invest in the pharmaceutical sector. Are there any index funds investing in the pharmaceutical sector? Additionally, please elaborate on the pros and cons of investing in mutual funds tracking such indices.

G. Chockalingam, Hyderabad, Telengana

The Nifty Pharma Index stands as a pivotal benchmark for gauging the performance of India's pharmaceutical sector, which is renowned for its robust growth and significant contributions to the global market. This index is meticulously designed to reflect the behavior and performance of pharmaceutical companies listed on the National Stock Exchange (NSE), offering investors and analysts a comprehensive view of the sector's health and trends.

With a mix of large-cap and mid-cap companies, the index provides a diversified exposure to the pharmaceutical industry, encompassing various segments such as generics, formulations, active pharmaceutical ingredients (APIs), and biologics. The index's performance is also a reflection of the broader economic and regulatory environment, government policies, pricing regulations, and healthcare initiatives can significantly impact the pharmaceutical sector. Moreover, global events such as pandemics or changes in patent laws can create waves that are felt across the index.

The recent performance of the Nifty Pharma Index in the past one year has been particularly noteworthy. This bullish sentiment is attributed to several factors, including the increasing demand for pharmaceutical products, both domestically and internationally, and the sector's continuous innovation and expansion into new markets.

Eligibility criterion of the Nifty Pharma Index

To be considered for inclusion in the Nifty Pharma Index, companies must satisfy a stringent set of criteria that ensure only the most relevant and liquid stocks are represented. These criteria serve as a quality check, affirming that the index accurately reflects the sector's health and trends.

• Listing on the NSE: The primary requirement is that the company must be listed on the National Stock Exchange of India, ensuring that it is subject to the regulatory standards and transparency required by one of the country's premier stock exchanges.
• Part of the Nifty500: The company should be a constituent of the Nifty 500 Index at the time of review. This criterion ensures that the company is among the top 500 companies on the NSE in terms of market capitalization.
• Pharmaceutical sector classification: The company must be classified within the pharmaceutical sector. This includes companies engaged in the manufacturing of pharmaceuticals and biotechnology companies.
• Trading frequency: The company's shares should have a trading frequency of at least 90% in the last six months, indicating consistent investor interest and liquidity.
• Listing history: A minimum listing history of 6 months is required, which allows for the assessment of the company's stock performance and investor response over a reasonable period.
• Free-Float market capitalization: The final selection of companies is based on free-float market capitalization, which reflects the market value of the company's shares that are available for trading and not held by promoters or other locked-in parties.
• Corporate governance and compliance: Companies must have a track record of adherence to good corporate governance practices and regulatory compliance, underscoring their reliability and stability.

The Nifty Pharma Index is reviewed and rebalanced semi-annually. This periodic review ensures that the index remains up-to-date with the current market conditions and continues to represent the pharmaceutical sector accurately. During the rebalancing process, companies may be added or removed based on their performance, market capitalization, and compliance with the eligibility criteria.

Top 10 constituents of the Nifty Pharma Index

The index is composed of 20 stocks that are considered leaders in the pharma sector, reflecting the behavior and performance of this vital segment of the economy.

Here's a detailed look at the top ten constituents of the Nifty Pharma Index:

• Sun Pharmaceutical Industries Ltd: As India's largest pharma company, Sun Pharma has a significant presence in the US market and offers a vast portfolio of products, including formulations and active pharmaceutical ingredients (APIs).
• Dr. Reddy's Laboratories Ltd: Known for its extensive range of generic drugs, Dr. Reddy's is a multinational corporation providing affordable and innovative medicines across the globe.
• Cipla Ltd: With a history dating back to 1935, Cipla has emerged as one of the top pharmaceutical companies in India, focusing on high-quality, branded generics.
• Torrent Pharmaceutical Ltd: Torrent Pharma is recognized for its presence in the therapeutic areas of cardiovascular, central nervous system, gastrointestinal, and women's healthcare
• Lupin Ltd: Lupin is a significant player in the generics market, with a strong emphasis on cardiovascular, diabetology, asthma, pediatric, CNS, GI, anti-infective, and NSAID segments.
• Zydus Lifesciences Ltd: Operating under the brand name Zydus Cadila, the company is well-known for its innovative R&D and a wide range of pharmaceutical products.
• Alkem Laboratories Ltd: Alkem is a leading Indian pharmaceutical company with a comprehensive portfolio of over 700 brands covering all major therapeutic segments.
• Divi's Laboratories Ltd: Specializing in APIs and intermediates, Divi's Laboratories is one of the top custom synthesis companies globally, with a strong focus on exports.
• Aurobindo Pharma Ltd: Aurobindo Pharma is renowned for its cost-effective manufacturing capabilities and is one of the largest producers of generic drugs in the world.
• Glenmark Pharmaceutical Ltd: A pioneer in biopharmaceuticals, Glenmark has been at the forefront of biologic drug development.

The Nifty Pharma Index is recalibrated semi-annually, ensuring that it accurately reflects the current state of the pharmaceutical industry in India. The companies listed in the index are not only leaders in the domestic market but also have a significant international presence, contributing to the global healthcare system.

Performance and returns and comparison with Nifty 50

As of August 30, 2024, the Nifty Pharma Index has given a one-year total return of 54.84%. It has given a 5 year compounded annual return of 24.44%. On the other hand, as of August 30, 2024, the Nifty 50 Index has given a one-year total return of 32.64%. It has given a 5 year compounded annual return of 19.39%.

Note:Past performance is not an indication of future returns.

Pros and cons of investing in index mutual funds tracking pharma index

Investing in index mutual funds, especially those tracking the Nifty Pharma Index, can be a strategic move for investors looking to diversify their portfolio and tap into the potential of the pharmaceutical sector.

Pros

• Diversification and risk management: One of the primary benefits of investing in index mutual funds is the inherent diversification they offer. By mirroring a market index, these funds spread out the investment across various companies, mitigating the risk associated with individual stock performance. The Nifty Pharma Index, which reflects the behavior and performance of the pharmaceutical sector in India, provides a focused yet diversified exposure to this industry.
• Cost-effectiveness: Index mutual funds are known for their cost efficiency. They are typically passively managed, which means they have lower expense ratios compared to actively managed funds. This is because they aim to replicate the performance of an index rather than outperform it, thereby reducing the need for active management and, consequently, the fees associated.
• Sector-specific growth potential: The Nifty Pharma Index offers investors a chance to capitalize on the growth potential of the pharmaceutical sector. With healthcare being a critical industry, especially in the wake of global health challenges, the sector has seen significant growth. Investing in an index fund tracking the Nifty Pharma Index allows investors to potentially benefit from this upward trend.
• Liquidity and accessibility: Index mutual funds, including those tracking the Nifty Pharma Index, typically offer high liquidity, meaning investors can buy and sell shares of the fund with relative ease. This accessibility makes it convenient for investors to adjust their portfolio according to their financial goals and market conditions.

Cons

Limited flexibility: Since index funds aim to replicate an index, fund managers do not have the discretion to make changes based on market conditions or opportunities outside of the index's constituents.

Sector-specific risks: Investing in a sector-specific index fund like the Nifty Pharma Index exposes investors to risks associated with that particular industry, such as regulatory changes or drug approval processes.

Taxation of investment made in mutual funds tracking Nifty Pharma Index

The Union Budget of 2024 has brought about significant changes in the taxation of mutual funds, particularly those tracking sectoral indices like the Nifty Pharma Index. Investors looking to understand the impact of these changes on their investments in such index mutual funds will find the following information crucial for making informed decisions.

Taxation before Budget 2024

Prior to the Budget 2024, investments in index mutual funds were treated as equity-oriented funds for tax purposes. This meant that Long-Term Capital Gains (LTCG) over ₹1 lakh were taxed at 10%, while Short-Term Capital Gains (STCG) were taxed at 15%.

Changes introduced in Budget 2024

The latest budget has introduced nuanced changes to the taxation of equity-oriented funds, including index mutual funds. The STCG tax rate for equity mutual funds has been increased to 20%. On the other hand, LTCG from equity mutual funds will continue to attract a tax rate of 12.5%, provided the holding period exceeds 12 months.

Impact on investors

Investors in index mutual funds tracking the Nifty Pharma Index must now re-evaluate their investment strategies based on the new tax regulations. The changes could affect the net return.

Conclusion

The Nifty Pharma Index is more than just a number on a screen; it is a testament to the dynamism and potential of India's pharmaceutical sector. For investors, it offers a gateway to participate in the growth story of an industry that is essential to global health and well-being. As the sector continues to evolve, the Nifty Pharma Index will undoubtedly remain a key indicator of its progress and prospects.

Investing in index mutual funds that track the Nifty Pharma Index combines the advantages of broad market exposure, cost efficiency, and the potential for consistent performance with the added benefit of focusing on a sector that has shown resilience and growth. As with any investment, it's crucial to consider individual financial goals and risk tolerance before making investment decisions.

Kuvera is a free direct mutual fund investing platform. Unless otherwise stated data sourced from BSE, NSE and kuvera.