Periods of market turbulence lead to a flight to quality, or a flight to value.
When the markets are making new highs every day, solid large-cap value stocks are nobody’s favourite, as everybody is busy chasing growth stocks. It’s only when investors start having doubts about growth that attention shifts back to value investing.
Investors have for long been divided into two camps—those who believe in growth stocks, in the belief that their superior earnings growth justifies the price, and those who believe in hunting for under-priced stocks that offer value.
Growth investors believe in buying stocks with above-average earnings growth, no matter what the price. Value investors look exclusively for “bargains”, or stocks that are trading at a discount to their usual valuation.
Of course, the growth versus value debate is also a caricature—most investors opt for a mix of growth and value stocks. But many funds have sprung up to take advantage of the distinction between these two investing styles.
Which of them have done better during the recent sell-off?
MSCI Barra has a set of indices that distinguish between growth and value stocks and they show that while the world growth index has fallen 1.09% in August (till the 24th), the index of world value stocks is down 0.59%. That’s exactly as expected, since investors flock to value stocks during sell-offs. The MSCI US value index is up 2.33% this month, while the growth index is up 0.89%.
Emerging markets, however, are a sub-set of the growth stock universe, which is why both the emerging market growth stocks as well as the value stocks have been hammered. The EM growth stocks in the MSCI Barra universe are down 6.59% this month, while EM value stocks are down 6.53%. So the sell-off hasn’t spared EM value stocks.
Year to date, emerging market value stocks are up 14.9%, compared with EM growth stocks being up 13%. The MSCI India value index is down 9.4% this month, while the India growth index is lower by 10.02%—only a marginal difference.
Proponents of value investing claim that value stocks do better over the longer term. That appears to be true for the US, where the MSCI Value index has given annualized returns of 4.82% over the last ten years, while the growth index has grown 4.10%.
But in India, value stocks have scored over growth stocks this year, over a one-year period, over the last two years and over the last five years. That’s surprising, because India is supposed to be a growth story. It’s only over a 10-year period that the MSCI India growth index has delivered higher annualized returns than the value index.
Open interest succumbs
Local equity derivatives players, who were hardly perturbed by the global liquidity crunch, are now paring their positions in the futures market, thanks to the double whammy of political instability.
Global liquidity fears had hardly bothered local equity derivatives players, who increased their exposure gradually in the equity futures market while foreign institutional investors (FIIs) were selling.
Between 9 and 17 August, when FIIs were net sellers in the futures market worth Rs5,000 crore, local players had been net buyers. This is because the outstanding positions in the futures market had fallen just 2% to Rs59,800 crore. Since the markets fell by 8% in value in the same period, open interest in terms of number of contracts outstanding would have risen.
This changed in the past week—open interest in futures contracts fell 14% to Rs51,000 crore by 23 August, although the markets were flat in the same period. What’s more, FIIs were net buyers of contracts worth over Rs6,300 crore in the futures market during the period.
While some of these trades could be close-outs of earlier sell transactions, it’s unlikely that FIIs were responsible for the drop in outstanding positions in the past week.
The increased uncertainty in the domestic political situation seems to have spooked local players, who had somehow withstood the huge sales from FIIs earlier.
With the date for futures expiry coming nearer, players do not want to risk keeping large open positions because of the volatility in the market.
Yet, it’s important to note that open interest on futures contracts has fallen by only 15% from its peak in the current correction.
Back in May 2006, open interest had fallen by 30% in a matter of seven trading sessions, data compiled by Edelweiss Securities show.
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