Most Indian investors, however, find it difficult to differentiate between a value fund and other funds. They flock to funds that give the highest returns. Truth is, value funds have a more logical approach when it comes to picking stock.
How they work
Broadly, there are three investment styles: value, growth and blend. Unlike growth funds, value funds focus on attractive valuations and not high future earnings. Blend, as the name suggests, combines both the styles. Value investing is more like cherry-picking, where fund managers pick fundamentally good stocks from sectors going through a lean patch. “We look for sectors that are out of favour with investors, making them cheaper,” says Sankaran Naren, chief investment officer, ICICI Prudential Mutual Fund, who also manages ICICI Prudential Discovery Fund. The definition of value, however, varies across fund houses and their managers. Says Swati Kulkarni, fund manager, UTI Mutual Fund: “Value is a relative concept—the stock's valuation should be lower than either the sector's average valuation or the benchmark's valuation.” For instance, if the market is trading at 20 times its price-earnings (PE) multiple, a stock that is trading at 15 times its PE can be called a value find provided, of course, it has sound fundamentals and there is enough visibility on future earnings. Kulkarni adds that another way to find value buys is to look for stocks whose current valuation is lower than their historical valuation.
Unearthing Value
In emerging markets like India, it is not tough to spot attractively valued stocks with sound earnings potential. In the 2008 market turmoil, for example, the Indian auto sector took a major beating amid high raw material costs and slack in demand. However, value investors saw this as an opportunity, acquiring names such as Bajaj Auto and Hero Honda Motors. These value picks helped those funds deliver superior returns in 2009-2010. Even in the current scenario, some value fund managers are taking exposure to stocks of banks and petroleum marketing companies due to higher inflation and rising crude oil prices.
Says Chetan Sehgal, chief investment officer/India–emerging markets group, Franklin Templeton Mutual Fund: “Irrespective of market levels, there will always be companies that meet the investment requirements of a value fund. Security prices fluctuate more than underlying security values, throwing up varied opportunities across market cycles”.
The Large-Cap Advantage
Value funds with a large-cap bias have outperformed others on a five-year basis
Top five funds with higher tilt towards value investments Returns as on 07 Feb 2011 AUM and portfolio data as on 31 Jan 2011 Returns less than a year are absolute or CAGR Source: mutualfundsindia.com
Market cap and Value funds
Value funds are usually multi-cap in nature, with a tilt towards either large-caps or mid- and small-caps. Though returns have mostly been handsome from both the categories, outperformance has been sharper by large-cap oriented value funds (see The Large-Cap Advantage).
Performance
In the last three years, value funds such as ICICI Prudential Discovery, Tata Equity P/E, Templeton India Growth and UTI Master Value have delivered an average return of 11 per cent as against the diversified equity category average of 1.49 per cent. Even over periods as long as five years, these funds have beaten the market comfortably.
When it comes to containing falls, they are almost on a par with the rest of the market. In 2008, while most mid- and small-cap funds were beaten down with more than 60 per cent erosion in their net asset values (NAVs), the fall in the NAVs of value funds was about 50 per cent, in line with that of the major market indices.
What you should do
The typical value stock may not appreciate for a long time, so you need to have patience if you invest in them. In fact, as the portfolios of value funds comprise undervalued stocks, they could get battered in a downturn. Look at the fund manager's credentials before you invest in a value fund. Avoid lump sum investments in them as they could be risky over short periods. Experts say that value funds should account for 20-30 per cent of your total fund portfolio, and all investments in them should strictly be made through the systematic investment plan (SIP) route.
Go for value funds that have a large-cap bias—besides the fact that they have generated higher returns so far, your money is also safer when invested in them.
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