Can investing in growth funds help your wealth grow?
Most people around the world have a passion for the equity markets, due to its ability to accentuate wealth creation (and thereby also beat inflation risk). While all of us invest in the equity markets to make money, you need to assess what is your stock-picking style which will eventually classify you either as a "value investor" or a "growth investor".
But very often many investors fail to assess that, as the habit of short-term or intra-day trading, infused by sheer excitement created by brokers / distributors / relationship manager or a favourite glamorous business channels, sways them.The brokers / distributors / relationship manager and favourite glamorous business channels provide you the short-lived khabar (news) in market, and loosen your focus from long-term investing habits.
Remember, by indulging in trading you are playing with the momentum or khabar (news) in the market and not engaging in investment activity with either growth style or value style. Moreover, by doing so, you end up creating wealth for your broker (as they earn luring brokerage fee on such trading), rather than creating wealth for yourself.
It is noteworthy that every style of investing - be it "value investing"or "growth investing", has their own set of principles on the basis of which stock-picking activity is undertaken. Both focus on fundamental attributes, but the major difference between them is that while a value investor may look at some stocks which are out of favour due to a bad news, but which they think will improve in the long-term (due to the robustness of the industry / company); a growth investor looks at good news which they expect it to be better for the company thus enhancing their return on investments.
But having said that, alike value investing growth investing too requires patience as very rightly mentioned by father of growth investing - Mr. Thomas Rowe Price.
"The growth stock theory of investing requires patience, but is less stressful than trading, generally has less risk, and reduces brokerage commissions and income taxes." - Thomas Rowe Price, Jr. (Father of growth investing and founder of T. Rowe Price Associates)
In this article let's turn our focus on more towards growth investing and understand how growth investing can benefit you.
Growth investing focuses on the following factors for stock-picking:
But having its distinct principles in place, growth investing also follows some of the value investing principles while selecting companies such as:
- Accelerating earnings - Yes, it looks at companies which are able to deliver above-average earnings growth by having with them a strong competitive position and opportunities (of further growth) galore, thus enabling them to pursue the growth path.
- Higher PE (Price to Earning) multiple - As the expectations of the company accelerating on the return front are in place, growth investing focuses on investing in companies offering a higher PE multiple, but at the same time making it inexpensive when looked at the future growth potentials it has to offer.
- Lower dividend yields - Also, apart from having delivered above-average earnings, growth investing focuses on investing in companies which are very conservative in declaring dividends, but which use the accruals for facilitating growth for the company (by having good expansion and acquisition plans in place).
Hence, even the legendary value investor - Mr Warren Buffett too states that there's no theoretical difference between value investing and growth investing. "Growth and Value Investing are joined at the hip" - Warren Buffett. And hence recognising that, later Mr Peter Lynch pioneered the concept of GARP (Growth at Reasonable Prices) investing wherein he mentions that one should look at consistent earnings growth which are above the market level (which reflects a precept of growth investing!) but at the same time avoid companies that are having high valuations (which reflects a precept of value investing!) while following growth investing.
- Companies should have a sound management
- Robust business model
- Buying at the right price
- Prudent approach toward debt financing
- Long-term investment approach
While this may sound a little complex and you may - "how is it possible for a layman to assess what is above-average earnings, PE multiple, dividend yield, GARP etc while following growth investing?"
Yes we certainly agree that it is a daunting task, and also think that if you do not have the wherewithal to position your equity portfolio in a growth style (taking into account the aforementioned factors to be looked into) you may end-up with either beta returns or even erode wealth.
But you still can position your equity portfolio in a growth style even though you are unable to carry out extensive research. How? You can simply focus on investing in growth style mutual funds (which follow strong investment processes and systems) for accentuating your wealth by providing superior alpha returns. However while selecting such mutual funds too; care should be taken since you should ideally include only consistent performing ones in your portfolio.
How Growth Funds have fared?
(NAV data is as on May10, 2011. Standard Deviation and Sharpe ratio is calculated over a 3-Yr period.
Turnover Ratio (%)
|Sundaram Select Midcap (G)
|Fidelity India Growth (G)
|HDFC Growth (G)
|Reliance Growth-Ret (G)
|Franklin India High Growth Cos (G)
|Sahara Growth (G)
|SBI Magnum Multiplier Plus'93 (G)
|Religare Growth (G)
|LIC Nomura MF Growth (G)
|Tata Growth (G)
|Morgan Stanley Growth (G)
|L&T Growth (G)
|Sundaram Growth Fund (G)
|Principal Growth (G)
Risk-free rate is assumed to be 6.37%)
(Source: ACE MF, PersonalFN Research)
So far as revealed by the table above, growth style funds have delivered quite an appealing performance - especially over a 2-Yr time frame. Yes over a 3-Yr and 5-Yr time frame they have paled on the return front. The reasons for returns (3-Yr and 5-Yr) turning pale could be companies being adversely impacted due to occurrence of the following factors in the last 3 to 5 years:
- Increase in borrowing costs (due to rising interest rates scenario) hindering the company's expansion or acquisition plans
- Rise in input costs
- Rise in labour cost (due to expectation of better pay to compensated elevated cost of living attributed by inflation)
- Drop in profit margins
- Global risk such U.S. Sub-prime mortgage crisis, Lehman Brothers bankruptcy, Debt overhang situation in the Euro zone, Dubai debacle, etc.
- Other company specific risks
But nonetheless if we assess the risk taken to deliver the returns they have been well controlled (as revealed by the Standard Deviation), which in turn is reflected in the risk-adjusted returns (as revealed by the Sharpe Ratio).
Moreover, with the portfolio being built with a focus on long-term investing (along with the other growth investing principles), irrational or aggressive churning too isn't reflected; barring some funds where the fund managers has indulged overtly in churning (thereby pushing the expense ratio upwards).
Portfolio Characteristics and strategy:
While building their portfolio, most growth style funds follow the Peter Lynch pioneered concept i.e. GARP. They lookforward to companies that show consistent above-average earnings growth, while excluding companies that have higher valuations. This approach thus helps them to strike a balance between extremes of growth investing and value investing. For their stock-picking activity they (growth funds) follow a bottom-up approach, thereby focusing more on the company specifics rather than industry favouritism.
However, the stock bets taken by fund managers of growth funds can be across market capitalisations (i.e. large caps, mid caps and / or small caps), along with ascertaining special situations for stock-picking; but in a manner which enables fund managers of such funds to discovers growth at reasonable price.
Note: Sector holdings as on April 30, 2011 of growth funds in the peer comparison
table, have been taken for top-10 sector calculation.
Top 10 stocks are also consolidated of growth funds in the peer comparison table
(Source: ACE MF, PersonalFN Research)
Hence, if we look at it from the sector allocation point of view too, we may discover growth funds taking large sector bets where the high PE multiples offer potential of high growth in respective sectors, but at the same time being fairly diversified. At present it is evident from the chart and table above that most growth funds have taken a dominant exposure to the banking stocks (such as ICICI Bank, State Bank of India, IndusInd Bank, etc) assessing their potential for future earnings and evaluating the fact their valuations are appearing reasonable due to the price correction occurred in them on account of Reserve Bank of India's (RBI's) stance of increasing policy rates to tame inflation.
Well, such funds are appropriate if you are willing to bear high risk for high growth. Moreover, the risk further accentuates if the fund managers discover most of it high growth opportunities in the mid and small cap segment.
But, as mentioned earlier if one invests in such funds which follow strong investments systems and processes, the risk is well controlled as momentum playing is curtailed, thereby offering an opportunity for accelerating wealth creation in the long-term.
Remember, your objective of wealth creation may not be accentuated by trading because trader is as good as his last trade. There is no assurance that every trade will spin the wheel of money for you. To create wealth over the long-term invest in equity mutual funds which follow strong investment processes and systems, and invest regularly by enrolling for a Systematic Investment Plan (SIP), as this would enable you to manage the volatility of the equity markets well (through rupee-cost averaging) as well as provide you with advantage of power of compounding.
PersonalFN is a Mumbai based personal finance firm offering Financial Planning and Mutual Fund Research services.
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