Value investing is premised on buying stocks that are available at a discount to their intrinsic worth. It is an idea made famous by Benjamin Graham, an investment guru of huge international repute who remains popular to this day. A value investor buys stocks and waits for the market to recognize their potential. However, value funds have delivered returns ranging from modest to poor over the past five years, testing the patience of investors.

In an interview with Mint in July 2018, Vetri Subramaniam, group president and head of equity at UTI Asset Management Co. Ltd, said value investing hasn’t worked in the past eight to nine years but expressed hope that the cycle may turn. We explore what ails these funds and what investors should do about them.

Poor performance

The category of value and contra funds is very heterogeneous and an average of returns is not as meaningful as in other categories of funds. For reference, however, as of 1 January 2020, value funds delivered an average of 2.4%, 8.9% and 7.2%, over one, three and five years. Multi-cap funds, their closest counterparts, delivered 9.6%, 12.2% and 8.47%, respectively, over the same time periods. The divergence in returns is much higher as compared to the Nifty or Sensex. The largest fund in this category, ICICI Prudential Value Discovery, did worse than the average. Its one-, three- and five-year returns are 0.9%, 6.2%, and 5.7%, respectively. The fund’s size is 15,188 crore (as of 30 November 2019), and a large number of investors have felt the pinch.

“At present, it is not growth investing that is dominant, but momentum investing. The latter rests on the idea that whatever is doing well will continue to do well. Investors in value funds need to wait for the cycle to turn; they need to have patience," said Mrinal Singh, deputy chief investment officer (equity) and fund manager, ICICI Prudential Value Discovery Fund.

Widening gap
Widening gap

What’s ailing them?

Some fund managers say value funds are underperforming in line with the broader market. This is because value funds fall in the “go anywhere" category—they can be large-, mid- or even small-cap in nature. In practice, they tend to have a substantial mid- and small-cap exposure. “There has been significant polarization in the market with the fear of a deeper global slowdown leading to low-risk appetite, in turn resulting in a lot of money moving out of the broad market and chasing predictable high-growth, high-quality companies. Funds with a value orientation ideally cannot or do not invest in these overpriced stocks, while on the other end, the broad market stocks where value funds invest underperformed and became cheaper," said Venugopal Manghat, head, equities, L&T Mutual Fund. He also highlighted a sectoral angle. “The FMCG space in the consumption basket is a case in point. Here, valuations are very high and value-oriented funds have negligible exposure," he said.

Financial advisers say the fact that value investing is a subjective concept is another reason why these funds may be in the doldrums. “Fund managers whose performance is judged frequently have gravitated towards including growth stocks in their value funds and have tweaked styles. For example, ICICI Prudential Value Discovery focuses on value but has moved from a mid-cap to a large-cap orientation as evidenced by a change in its benchmark a few years ago," said Nithin Sasikumar, co-founder, Investography, a financial planning firm. “In India, value funds don’t really follow a value strategy as it is internationally understood. They have some value stocks, but you should compare them to multi-, mid- or small-cap funds," said Dhaval Kapadia, director, investment advisory, Morningstar India Pvt. Ltd.

Some schemes such as Tata Equity PE Fund are mandated to follow the value principle. This fund is required to invest at least 70% of its portfolio in stocks with a price-to-earnings (PE) ratio below the Sensex PE. However, not all schemes agree on the metrics which establish them as “value". “We do not define value in simplistic terms like PE, PB (price-to-book) and dividend yield. We look at the margin of safety—whether the price we are paying gives us sufficient margin of safety if our needs are not met," said Singh.

Sasikumar said the size of a fund also affects performance. “A large size can result in its own undoing as it limits the ability of the fund manager to be flexible. There isn’t an exact science to this and whether it is a diversified, growth or value fund, assets under management greater than 10,000 crore call for more frequent reviews and monitoring," he said.

Some financial advisers skip the category altogether. “I don’t allocate based on growth and value. I choose funds based on market capitalization rather than themes. So I would not recommend such funds," said Harsh Roongta, a chartered accountant and Mumbai-based Sebi-registered financial adviser.

What should you do?

Fund managers urge investors to stay with these funds citing mean reversion. “Value investing has a down cycle every few years. This means a mean reversion sooner or later, and when that happens, value will outperform growth," said Sonam Udasi, fund manager, Tata Equity PE Fund. “Historically, it may be observed that at the start of a new up-cycle, deep value stocks perform better as compared to the rest of the market, especially expensive stocks. While the degree of outperformance and the recovery time can vary from the past trends, generally, when the divergence is so wide between a few high-growth or quality franchises and the rest of the market, a reversion of this trend can easily erase the underperformance of these funds," said Manghat.

Financial advisers recommend a long horizon. “The value category is essentially thematic. As a result, it is riskier than an ordinary diversified large- or multi-cap fund. The risk profile of the category is closer to mid- and small-cap funds. Hence, the ideal time horizon for this category is higher at seven years or longer," said Tarun Birani, founder and CEO, TBNG Capital Advisors Pvt. Ltd. “We recommend clients to exit if they don’t want to wait," he added.

Experts also ask investors to do their homework on the fund in question. “Some funds stick to a pure value mandate, while others are allowed to stray into growth stocks. For example, Invesco India Contra Fund can allocate up to 20% of its corpus to growth stocks. Neither strategy is better but you should know what strategy your fund is following before investing," said Vidya Bala, co-founder, PrimeInvestor.in.

You should also be careful about picking a fund that actually practises value investing. The relatively vague Sebi rules on this leave a lot of room for subjectivity and interpretation. Seek the help of a financial adviser to cull out such funds. You can also refer to the picks in this category in the Mint50.

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