India’s healthcare investing universe is expanding rapidly from hospitals and diagnostics to contract drug manufacturing and specialty care. DSP Mutual Fund is positioning for that shift with a sharper focus on CDMO companies, corporate hospitals and small- and mid-cap opportunities.

Chirag Dagli, who manages the DSP Healthcare Fund, believes CDMO could deliver the sector’s fastest earnings growth over the next five years as global pharmaceutical companies seek to reduce their dependence on China. At the same time, the fund is evaluating hospital expansion, hybrid diagnostics businesses and valuations to identify healthcare companies capable of sustaining growth.

The Rs 3,800 crore DSP Healthcare Fund has given a return of over 16% in the last one year. At the end of August, it owned around 9.2% in global equities while domestic smallcap exposure stood at 44.5%. The fund's top 5 holdings include IPCA Labs, Sun Pharma, Sai Life, Cipla and Apollo Hospitals.

Edited excerpts from a chat with the fund manager:

As the listed ecosystem in the healthcare sector in India keeps on expanding to CDMO, diagnostics, specialty hospitals, etc, how are you allocating capital in your fund to these new high-growth areas?

Newer businesses have continuously been added to the healthcare space in India over the past decade. Pre-Covid, we had only 3-4 listed hospitals; today, we have more than 15. Similarly, we had just one path lab; now we have six. Newer models like retail pharmacy have also come in. Bottom-up stock selection and evaluation of business models relative to valuations remain key. That remains our approach, with eventual portfolio weights being an outcome of this process.

Hospitals have significant bed expansion plans. How do you assess whether new beds will generate adequate returns, and which operating metrics matter most?

Hospital expansions by many corporate hospitals are happening in their core markets, where they are already seeing increased occupancy in their existing facilities. Filling these new beds should be easier than filling beds in new markets. We do differentiate between hospitals building in newer markets and those expanding in existing markets in terms of valuation multiples because execution risks are different. However, in many new markets, such as Bengaluru and Lucknow, corporate hospitals have done well.

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Diagnostics is facing competition from hospitals, online platforms and discount-led chains. What differentiates a durable diagnostics business from a low-margin volume player?

Competitive pressures have abated at the margin in diagnostics. Pathology is more competitive than radiology, as it is less capital intensive. For the last 5 years, we have held a view of owning hybrid path labs – ones that do both pathology and radiology. Even in pathology, while it is competitive, it is not easy to scale beyond a point. Online players have come in but have not been able to scale the business the way established chains have.

What is the investment case for allocating up to 10% of the portfolio to global MedTech leaders, and how do you manage currency and valuation risks?

As Indians, we consume devices, robotic surgery etc., but we don't have companies that can benefit from such consumption, as most of the players are global companies. Hence, we invest in these global companies.

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Within the healthcare segment, do you think that the CDMO space may record the highest earnings growth rate if you take the next 5-year stretch, despite all the lumpiness?

CDMO should grow fastest as Indian companies are seeing the benefits of pharma MNCs wanting to de-risk from China. This non-linear benefit helps growth. Indian companies have also risen to the opportunity and invested in factories to benefit from it. Other segments of healthcare generally have more linear, stable growth.

You have over 40% allocation in smallcaps in the fund. Are smallcap healthcare stocks the biggest growth engine?

Small cap exposure is a result of the bottom-up build of the portfolio. We had a large-cap skew in 2021 when we saw relative opportunity. Now we are seeing that in SMIDs.