How do you manage Templeton India Growth Fund (TIGF)?
TIGF is unique because it is one of the first emerging market funds that raise money from the local investors for the local investors. We don’t have too many such schemes. Other than this, all Templeton brand of schemes are managed in the same way. We search for value. To define value, we do a four-step analysis. First, we check whether a particular stock is cheap compared with the market. We also check how cheap it is vis-à-vis the industry as well as its own historical prices. We also check how cheap is the stock based on its own absolute price. Once we run these tests, we do a fundamental analysis. That TIGF invests only in India is a constraint, but we manage it well. A large chunk of our investments are in companies with a market capitalization in excess of $300 million.
TIGF predominantly invests in large-cap scrips. But wouldn’t you find more value in small- and mid-caps scrips?
Yes, small- and mid-cap companies offer value too. TGIF’s mandate is to veer towards large-sized companies—90-95% portfolio is invested in large-cap scrips. Also, it’s tough to differentiate it from peers when so many analysts and fund managers track the same set of stocks (large-caps). But we have managed to stay ahead in the large-cap fund race. Our portfolio turnover is probably among the lowest in the industry.
How is value philosophy different from a contrarian approach to picking stocks?
There was a philosophy called “Dogs of the Dow”, where you start buying the worst-performing stocks from the bottom on a quant screen and hopefully with mean reversion, you do well at the end of the period. When stock prices are low, contrarian investors may buy such stocks.
The value investing concept is fundamentally different. Index funds will argue that there can’t be a better indicator of the value of a stock than the present price. A value fund will attempt to differentiate value from this price. But the value can be based on the current differential between the price and the perception of the current value. We try and base our analysis on our estimate of five-year forward fundamentals. Then we look at the price taking at a discount to that future value. This is our definition of value.
Index providers classify value and growth differently. Broadly, if a stock has low price-to-earnings (P-E) or price-to-book (PB) value compared with the index, it is classified as value or else growth. High current PB value in growth stocks implies that growth expectations from these stocks are higher.
Usually well-managed value funds outperform growth funds when markets fall. In volatile markets, why do value funds pick such stocks?
One set of investment philosophy is to bet on companies that are doing well in the belief that since they have been successful, they would continue to do so. In rising markets, some investors use this philosophy and buy stocks that are performing well (some of these are real long-term winners). When markets fall or growth disappoints, these stocks fall the most as they are owned by a majority of investors.
The second set, or value investors, believe that most businesses tend to go in cycles and there is a period of expansion of business, heightened capacity expansion, followed by increased competition, drop in margins and an unfavourable environment. A majority of investors may blindly shun beaten down or ignored stocks as they don’t expect growth from them and this exacerbates the decline. Those invested in beaten-down stocks of companies with good medium- to long-term potential tend to do relatively well than those who had invested in growth stocks, when the markets turn as they are under-owned.
Why haven’t value funds picked up in India? Why haven’t we seen other fund houses focusing on value strategy?
There are some important things for a value strategy. If a stock price is different from its intrinsic value, there is an upside in the stock you buy. The only thing that limits this upside is corporate governance. For example, if a company has a land asset and the value of the land is far more than the market capitalization of the stock of this company, then there is value. But if somebody surreptitiously takes away this asset in one way or another, the investment case is lost.
The point is unless corporate governance norms are fully in force, value investors are at the mercy of company managements. Because if I know that there is value, I am sure the promoter also knows that there is a value. So it becomes a bit of an issue as to how does one enforce corporate governance. Unlike in the West, where shareholders are fragmented and investors can actually influence the way companies run (company sell-outs, mergers and so on), that does not happen in India. Here, the promoters of companies take key decisions. For value investing to truly succeed, corporate governance should be enforced.