‘Value investing hasn’t worked in past 8-9 years, but then cycles change’

Do you buy a stock when it is cheap or do you buy it when it’s expensive because it is growing fast? Vetri Subramaniam, group president and head of equity at UTI Asset Management Co. Ltd talks about the value investing style that he is known for. He also spoke about the unusual market where mid- and small-caps have struggled over the past two years and large-caps are led by only a few stocks, apart from the performance of two key mutual funds offered by the AMC

Mid- and small-caps have done poorly compared to large-cap over the last two years. What are your views on this?

The Nifty Midcap Index has outperformed the Nifty 50 when you look at 16-year data. The outperformance is in the region of 2-2.5% annualized over that period. But in the last 18 months, mid- and small-caps have underperformed quite dramatically. This follows a period of about three and a half years when mid- and small-caps outperformed the large-caps with margins far higher than anything we had ever seen. In January 2018, the annualized gap between the two was around 5-6% over a five-year period in favour of mid-caps, which is way over the historical norm. What was seen over the last 18 months is really a sort of mean reversion. Although we have seen periods in which mid-caps traded at a premium to large-caps, the historic norm is for them to trade at a slight discount. Today on a forward basis, mid- and small-caps are back to trading at a discount to the index. Also, the periods when mid-caps underperform large-caps are, typically, associated with weak economic growth numbers and tighter credit conditions, which has been the case in the recent past.

Value investing, a style you are known for, doesn’t seem to have worked out over the past few years. Are there grounds for a re-think?

Global data shows that from 2010, growth has been outperforming value by a wide margin. In the decade prior to that, it was the reverse with value doing far better and in the run-up to 2000, growth trounced value. These cycles can persist over many years and one large cycle is often interspersed with mini cycles. Value investing pays a lot of attention to the price at which a stock is bought, while growth focuses more on return on capital and free cash flows.

Value investing has not worked in the past eight to nine years, but then cycles change. Instead of looking at it (the strategies) as a timing device, people should understand the difference between managers. Since managers practice many different styles, you want manager and style diversification and not just diversification related to stocks.

On another note, value investing as “cigar butt” investing is a method that has faded away. That is an approach where you pick a cigar butt off the ground because there’s still a little butt left which you can smoke that is available for free. It involves buying something simply because it trades at less than liquidation value. But how many businesses in this country trade at less than liquidation value? Also, the reason for investing in equity is to benefit from growth in the value of the business over time.

Only a few stocks have driven the markets, over the past 12-18 months. Will that continue?

That’s not sustainable beyond a point. This has been the most challenging period to beat the benchmark.

Also, structurally, the level of sophistication due to the market being dominated by professional managers and institutions raises the skill level of participants and makes it harder to generate alpha. Note that we are now measuring performance against TRI (total return index). The cycle of the past 12-18 months will reverse at some point.

UTI Master Share and UTI Equity funds have lagged their benchmarks and peers. Why?

We have over 80% in large-caps in UTI Mastershare. The portfolio’s issues are more linked to what has happened in the large-cap space, where a few heavyweight stocks are leading the market. It has a healthy performance over two to three years versus peers but performance has lagged over the past year. UTI Equity Fund is a multi-cap scheme after its merger with UTI Bluechip Flexicap in May 2018. Prior to this UTI Bluechip Flexicap was a multi-cap and UTI Equity fund was a large-cap. UTI Equity was retained because it was the older and larger fund, but it now follows the multi-cap strategy of the erstwhile Bluechip Flexicap. The historical NAV (net asset value) is that of a large-cap scheme, which looks weak against the new peer group and new benchmark BSE 200.

On the one hand, there’s slowdown in some sectors, and on the other hand, interest rates are falling. Where will growth come from?

Some factors led to the slowdown. Credit went through a rough patch. India’s ability to grow exports has been weak for a long period of time and in the fourth quarter of the year, the government slammed the brakes on spending. Remember that government accounting is cash accounting—if they have not paid suppliers for goods or services rendered it is not accounted in the fiscal deficit. However, that has already changed. The government spent roughly ₹3.6 trillion more than what it received in the first quarter. The income transfer to farmers and tax rebates are also likely to take effect gradually. The Reserve Bank of India (RBI) has cut rates by 0.75% this year. With some lag, this will transmit to borrowers. Households who buy property are another important part of the investment cycle. We might see a little bit of a pleasant surprise there. We should see lower interest rates stimulating housing demand.

We are seeing an improvement from the trough but whether we will see a massive reversal in investment cycle is a bit of a question mark.