Are Value Funds Ready to Shine? - Outside View by PersonalFN

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Are Value Funds Ready to Shine?
May 12, 2021

Value funds, as you know, failed to generate attractive returns for investors in the last few years. The equity market witnessed a rollercoaster of events such as Demonetization, GST, liquidity crisis in NBFCs, economic slowdown etc. which impacted the growth at broader level. Since then only a few stocks have been driving the market movements. Consequently, value as an investment style turned out of favour.

Value funds look to discover undervalued stocks, i.e. stocks that are trading below their intrinsic/fair value, but with strong fundamentals, and hold them till their value is realised. As the fund managers of value funds invest in undervalued stocks, some of their bets may not pay off immediately. Thus, value funds can underperform over the short to medium term. Then again over the long term, value funds can generate returns in line with growth funds or even outperform them.

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And after a prolonged wait, value funds seem set for a comeback; the category has clocked superior performance in the last one year, outpacing many growth-oriented funds. The top performing value fund generated 116.5% returns in the last 1-year while the category average is 74.3% (as on May 10, 2021).

Table: Are value funds staging a comeback?
Scheme Name Absolute (%) CAGR (%)
1 Year 2 Years 3 Years 5 Years 7 Years
ICICI Pru Value Discovery Fund 76.73 21.77 13.60 14.02 17.04
UTI Value Opp Fund 68.55 20.29 13.10 14.56 13.50
Nippon India Value Fund 77.34 19.21 11.27 15.82 16.55
JM Value Fund 74.83 19.48 11.10 17.14 17.49
Quantum Long Term Equity Value Fund 71.63 12.99 9.20 11.69 12.53
L&T India Value Fund 73.00 17.87 8.93 15.00 18.99
IDFC Sterling Value Fund 116.48 19.63 8.06 16.40 17.43
HDFC Capital Builder Value Fund 69.73 12.92 7.56 13.78 14.52
Templeton India Value Fund 90.70 15.86 7.41 13.34 13.91
Tata Equity P/E Fund 53.59 14.35 6.51 15.77 16.81
S&P BSE 200 - TRI 67.44 18.35 12.83 15.55 14.43
S&P BSE 500 - TRI 70.2 18.62 12.18 15.47 14.54
Data as on May 10, 2021
(Source: ACE MF)

One of the reasons for value stocks turning attractive is that after a sharp run-up in a few index-heavyweights over the past few years, the valuation of these growth stocks have turned expensive and the margin of safety has narrowed. This is driving many investors away from growth stocks.

Notably, growth-oriented funds do not mind investing in certain high growth potential stocks even if it is available at slightly expensive valuations. But due to the impact of the second wave of COVID-19 there could be a downside risk to corporate earnings estimate. So till the time earnings justify the high valuations, prices of growth stocks may remain saturated and may even consolidate.

Value funds on the other hand could benefit from earnings upgrade in certain beaten-down sectors. The government last year instituted Production-linked incentive (PLI) scheme to boost domestic manufacturing and reduce reliance on imports along with measures to boost infrastructure growth.

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This could bode well for PSU stocks and stocks in sectors such as Automobile, IT, Power, Construction, Infrastructure, Telecom, Metal, Consumer Durables, etc. where value funds have higher allocations when compared to other equity mutual fund categories.

Value funds tend to underperform during momentum-driven market rallies, like the one witnessed in the last few years, which often leads to polarisation of market; but perform fell in settings where the market rally is broad-based and driven by fundamentals and earnings upgrade.

It is important to note that value funds can offer a better risk-reward potential because they are better positioned to manage the downside risk during a market fall, but they may not always participate well during a bull run.

Will the recovery sustain?

Even though the market is trading at high valuations, value buying opportunities exist in various beaten down sectors and certain quality stocks across the market capitalisation range. These stocks/sectors can bounce back when the pandemic-related uncertainties subside and demand revival takes place.

Amid the pandemic, corporates have focused on driving efficiency, deleveraging their balance sheets and undertaking cost-control measures that can translate into better corporate earnings growth. Besides, the current low interest rate scenario bodes well for corporates looking to raise capital.

Thus, an improvement in demand can result in higher revenue and profit. Therefore many value stocks still offer attractive value points and can benefit from re-rating as corporate earnings grow.

Value funds act as a good portfolio diversifier due to better margin of safety. So, the improvement in performance of value funds category should not be seen as an opportunity to redeem your investment. Before increasing/decreasing your portfolio allocation in value funds, consider its role in your overall asset allocation plan and your financial goals and then take suitable decision.

Value funds can form a part of your core portfolio; if you can handle an extended period of underperformance and if your investment horizon is at least 5-7 years.

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To conclude...

Both growth funds and value funds have their pros and cons. To get favourable returns across market phases and cycles, invest in a mix of growth and value style funds based on your personalised asset allocation plan.

It is often observed that some value funds take high exposure to growth stocks in a bid to boost returns. Such funds should ideally be avoided because the downside risk in such funds can be relatively high. So stick to value funds that focus on the guiding principles of 'Value Investing' while constructing the portfolio.

Moreover, to select a worthy value fund, analyse the schemes based on various quantitative and qualitative parameters, avoid investing in schemes based on its recent performance.

PS: If you wish to invest in a readymade portfolio of top recommended equity mutual funds based on the 'Core & Satellite' approach to investing, I suggest subscribing to PersonalFN's Premium Report, "The Strategic Funds Portfolio For 2025 (2021 Edition)".

At PersonalFN, we follow a comprehensive S.M.A.R.T Score Matrix to select the best mutual funds. We evaluate...

  • S - Systems and Processes
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This has helped our valued mutual fund research subscribers to own some of the best equity mutual fund schemes in the investment portfolio with a commendable long-term performance track record.

Subscribing to PersonalFN's Premium Report, "The Strategic Funds Portfolio For 2025 (2021 Edition) would help you build your optimum strategic mutual funds portfolio for 2025 with no effort on your part. If you haven't subscribed yet, do it now!

Author: Divya Grover

This article first appeared on PersonalFN here.

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PersonalFN is a Mumbai based personal finance firm offering Financial Planning and Mutual Fund Research services.

Disclaimer:

The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

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