The last 15 months have seen a recovery of sorts for funds focused on value investing. From the lows of March 2020, value funds have given a return of 86 percent on an average. That is more than what large-cap (70 percent), Large & Mid-cap (80 percent) and Flexi-cap mutual funds (74 percent) delivered. The Nifty 50 index gave 78 percent return during the period. IDFC Sterling Value Fund (ISVF) has been among the best in its category, notching up 115 percent over this timeframe. Can it do an encore?
A strong show after many years
Value funds may underperform benchmarks and other categories for years. These schemes identify stocks that are currently trading below their intrinsic value. When the cycle turns, such stocks are expected to deliver handsome returns.
But value investing did not deliver over the past decade, globally.
The steady decline in interest rates over the past few years has reduced the cost of capital, resulting in a higher multiples for future earnings, which in turn favoured growth stocks.
Further, in India, as economic growth remained sluggish for a long time, investors preferred a small bunch of stocks, leading to a narrow market rally.
In the last 10 years, the Nifty 500 Value 50-TRI outperformed the Nifty 500 TRI only three out of 10 times (see graph).
However, the wind turned in favour of value funds over the last one year. Samrat Khosla, Head, Wealth Management, India-Standard Chartered says, “The government’s fiscal boost, with a clear focus on reviving capex and rising inflation expectations with CPI being above RBI’s 4 percent target, were strong tailwinds for value strategy in 2020.”
Tilting towards small-cap stocks helped
After it registered sub-optimal performance within the category in 2018 and 2019, ISVF delivered well over the last 15 months, thanks to its stock and sector selections.
It is jointly managed by Anoop Bhasker and Daylynn Pinto.
Pinto says, “A larger exposure to small-cap stocks worked well. Our overweight positions in pro-cyclical sectors such as auto, infrastructure, cement, metals and basic industries helped the fund make a strong comeback over the last one year”.
Of the 15 funds in the category, ISVF has been among the few maintaining a high allocation of around 76 percent to mid and small-cap stocks. Mid and small-cap stocks registered phenomenal returns over the last 15 months, helping ISVF to outperform peers. However, higher mid and small-cap allocation can be risky, something that Pinto says he is conscious of.
Pinto’s choice of sectors also punished the fund for a long time. Value style does not work during falling bond yields, low inflation and muted economic growth. Cyclical sectors, in which value funds typically invest in, disappointed on the earnings front over the last decade, before the tide turned. As of May 2021, ISVF held more than 40 percent in these sectors.
Is the rally in value stocks sustainable?
Pinto believes that post-COVID, all economies would open up and there would be a good amount of economic recovery in the next 12 to 18 months.
Khosla of Standard Chartered expects the rally in value stocks to continue in 2021 for a few reasons. Apart from economic growth, improving inflation expectations tends to benefit value stocks as they represent a large portion of cyclical sectors such as financials and commodity-related segments.
Also value stocks have a strong positive correlation with nominal bond yields. A higher fiscal deficit and partial normalisation of some liquidity measures taken by the RBI could result in a spike in yields.
Should you invest?
Value funds reward only those who are patient for many years and are comfortable with subdued performance over long periods.
Also, it’s too early to say if value funds are convincingly on the revival path. Khosla asks investors need to be cognisant of the risks. If COVID continues to linger, economic growth disappoints and bond yields continue to decline, then value stocks could go down again. He advises that investors raise allocation to value strategies within a diversified equity portfolio.
ISVF’s higher allocation to mid and small-cap stocks poses higher risks. Investors with a high risk appetite and longer time horizon of 7-8 years can consider ISVF.