The Mutual Fund Show: Unlocking Outlier Returns With Value Investing
Something cannot be called value just because it is cheap, said Suresh Soni, CEO of Baroda BNP Paribas Asset Management.
Value investments can be a profitable bet, and complement growth-themed portfolios, if they are sustained for the required timeframe with knowhow to unlock their latent potential, experts said.
Something cannot be called value just because it is cheap, said Suresh Soni, CEO of Baroda BNP Paribas Asset Management.
"There has to be a way, or a reason why it would be valued properly by the market. Why will it become valuable from being value? So, you need to have one understanding of why it is trading where it is trading and secondly, a thesis for unlocking," he said.
Value theme deals with investments trading below their intrinsic value, explained Kshitiz Mahajan, managing partner and CEO, Complete Circle Wealth Solutions LLP Pvt.
"But value theme you see that companies are doing fine but for reasons these stocks are cyclical stocks, sectoral approach is there or let's say for some reason they are not getting whether there is some news around the corner... So, they are trading below their intrinsic value," said Mahajan.
Such stocks combined in a fund make up a value-approach strategy, which complement growth strategy well, he said.
Investors need to be patient with value funds as markets may take some time to recognise their intrinsic value, said Soni.
"They are good investments, but you just don't know how quickly they would be recognised by the market. Therefore, I would recommend investors a time horizon of at least three years for investing in these kinds of funds, because value in terms of the cycle to play out does take a certain amount of time," said Soni.
Nikhil Kothari, director at Etica Wealth Pvt., makes a case for value funds basis diversification, which can reap good returns when the time is right.
"I always say that... one should always have a one-year contra funds in their portfolio because they normally take longer timeframe to perform. But whenever the cycle turns, they can give outlier return, and sometimes growth play out and sometimes the value will. In the last two or three years, value cycle played out as compared to growth," said Kothari.
Watch the full video here:
Edited excerpts from the interview:
Let me start by asking about the value fund that you have just launched. What is the strategy? What category does it play in and why did you decide to launch the fund?
Suresh Soni: Value investing is essentially about buying something at a price lower than its intrinsic worth. So, that is the basic fundamental premise of it. Now, why would you get these opportunities? At what level do you get these opportunities? That is where we want to discuss a little bit.
So, the value happens because there could be times when a stock, sector, market, segment or the entire market could be out of favour from investor’s radar. Therefore, valuable opportunities can emerge either at the entire market level which is something that you saw post Lehman or let's say post Covid. It could happen in certain market segments where you find that there are times when the mid-cap or the small-cap segment can either be too cheap or can be too overheated.
That is something that we have experienced, or it can happen at sector level where there are certain sectors which are completely ignored by the market and finally at the stock level these are the opportunities which offer you essentially buying stocks or buying good companies at relatively reasonable valuations.
And the belief is that if you happen to buy them at valuations, which are lower than their long-term averages, or are lower than the long-term growth potential, then you not only benefit from the growth to business, but you also benefit from rewriting.
This particular scheme is a dedicated value fund. How does this gel with the strategy that you as a fund house espouse when you are managing active funds?
Suresh Soni: See as a fund house, when we are investing, we are obviously looking at companies which have potential to grow and generate wealth over a period of time. In the value fund you use a few additional screeners when you focus a little more towards the valuations of the companies.
Let me give you an example, you know the difference between let's say, buying a value stock versus buying a pure growth stock is essentially a growth stock does factor in a continuing growth momentum of a company whereas in a value stock, you are essentially looking at some changes in the company or some changes to occur in order to unlock that wealth and those are the two differences between the approaches per se.
So, overall, I think finding a value is just the starting point, then you wait towards understanding as to why is the stock trading, where it is trading and what would unlock that value in future.
But as a fund house, you have both strategies that you espouse, right?
Suresh Soni: As a fund house we indeed espouse both the strategies. There are funds that are managed on the overall growth strategy, growth-enabled price and then there are one which are focused on value, and this is the one that we are focusing on value and indeed there be a distinction in the way we run versus the other funds.
What according to you is the difference between that holding period when it comes to value versus growth and what should an investor bear in mind if they are looking forward to investing in this fund or in this category?
Suresh Soni: So, in terms of time horizon, in growth, you are already talking about the companies which are primed by the market, which are very well established in their area, and therefore they have a growth momentum behind them. There is in case of value, you look for opportunities, which will be out of favour.
You know, they are good investments, but you just don't know how quickly they would be recognised by the market. Therefore, I would recommend investors a time horizon of at least three years for investing in these kinds of funds, because value in terms of the cycle to play out does take a certain amount of time.
Could we then anticipate that the portfolio will have a tilt towards the smaller market cap or the middle-end of the market?
Suresh Soni: I would say we have a flexi-cap approach. So, we will go and straddle all the segments of the market and you know, it is wrong to say that we will be able to find value only in the small cap.
I mean, all of us are very familiar that there was news floating around about of some of the large-cap companies just not so far back. Therefore, the value does occur at all the places on the market whether it is small cap, mid cap, or large cap.
Incidentally, the stock you just spoke about hit a 52-week high, just this week.
Suresh Soni: Absolutely, indeed, the market tends to sometimes overreact on either sides and there are opportunities which are available across the market cap.
Finally, what are the pitfalls that one should bear in mind?
Suresh Soni: A couple of things, first, just because something is cheap, cannot be called value. There has to be a way, or a reason why it would be valued properly by the market. Why will it become valuable from being value? So, you need to have one understanding of why it is trading where it is trading and secondly, a thesis for unlocking.
You just don't buy low P/E in particular in the case of cyclical sectors. I think more often than not, you actually sell them at the peak of the earning, when the P/E ratio appears to be low, and you on the contrary buy them, when the industry is going through a tough phase. But at the same time, you know that these are the companies which are going to survive.
Seemingly the P/E ratio may appear higher but that's at the bottom of the cycle and therefore you have a much more constructive way. So, it is not only price-earnings ratio, but you also look for the initial parameter, which is relevant to that particular sector, that particular industry and then go deeper into what is leading to the current undervaluation and finally, what would lead to unlocking of the value eventually.
Kshitiz, what do you think about the value fund category?
Kshitiz Mahajan: As we say there are different baskets of funds which have been offered and value is one of the investing approach, which normally is of a theme that they will buy into companies which are trading less than their intrinsic value or let's say where you see that they are not getting the due price which they deserve.
The companies they are buying in the portfolio, so, in many cases we have seen most of the strategies are growth oriented, where we buy into those companies which are very high on growth, and where we see the growth coming, which are at the high valuations also, but you don't mind buying those companies because you expect the growth to be compensating those high valuations.
But value theme you see that companies are doing fine but for reasons these stocks are cyclical stocks, sectoral approach is there or let's say for some reason they are not getting whether there is some news around the corner. Let's take for example HDFC Bank- HDFC Ltd., the merger is about to happen, but it can be any other reason also that they are not getting the right price. So, they are trading below their intrinsic value, which is the real value which one can expect to give to these stocks.
So, when you combine those stocks in a basket and make up a fund, that is what we call a value-approach strategy. So, I think it's a very good complement to the growth strategy and that's how this approach has been carved out almost 15-16 years back by mutual fund houses.
Initial thoughts Nikhil.
Nikhil Kothari: So, in a portfolio I am saying, when you are even addressing a portfolio, you need to have scheme across different categories and across different strategies, because that's what diversification leads to. If you have two funds which are both following the growth side and ideally, there is not too much diversification.
So, when you construct your portfolio, once you look at different categories of fund in terms of one can be large-cap fund, one can be mid cap, one can be small-cap and in that also, you can follow the three, three committees type one is growth at any cost.
There is growth at reasonable price and there is value. So, out of these three categories one can have a portfolio, one can look at growth funds and some at value funds. I always say that in one category of in one portfolio, one should always have a one-year contra funds in their portfolio because they normally take longer timeframe to perform.
But whenever the cycle turns, they can give outlier return, and sometimes growth play out and sometimes the value will. In the last two or three years is also value cycle played out as compared to growth. So, in that case, the right portfolio is divestment, and the average returns are taking care of that.
Kshitiz, should you go for a scheme that is specifically value or should you have a wider approach?
Kshitiz Mahajan: So, on an average, we have four to five schemes which we recommend a client should have in his portfolio or ELSS and others. Let's say, if you are having a sectoral buy in your portfolio, you want to have far more healthcare or let's say I.T. fund, but you asked me so I would like to keep it simple, I would like to have one for a new investor, an index fund, couple of focused or multi-cap fund or larger mid-cap fund or a mid-cap fund depending on risk appetite mid or small cap fund, complementing it with a value fund.
So, that is what I feel but yes, there are fund houses which offer you a mix of strategies also, wherein you have a value as well as you have growth-oriented stocks. Just to make this entire mood a little light, you would be surprised and many of the growth stocks have become value of late especially I.T. stocks, you know, now Infosys is as good as like a value buy right now at these levels because it's trading at 13-14-15000 Nifty level, where Nifty is at 18000 level.
HDFC Bank is a value buy as on date because the merger is about to happen. ITC a year back was a value buy irrespective of it is a growth-oriented company. So, you know, from where I come normally, you know, and my fellow colleague has explained it beautifully that sometimes some strategies will pay out and sometimes some strategy will play out.
But if you actually want to have the real essence of that value play then one should have a pure value fund and it should be a part of anybody's portfolio because yes, both the strategy will not go in one tandem but at the same time when the cycle will turn it will play out really well for clients and cycles have shortened.
Earlier for any sector also, let's say, a commodity also we used to have a long-drawn cycle, six years, seven years, eight years, the cycles have also shortened, it's like the way our screen time has shortened, the way our screen will shorten, equity cycles, commodity cycles have also shortened.
We won't see seven-eight year cycle, so my submission here is one should have a pure value fund in the portfolio and believe me I have been analysing all the focused fund, multi-cap fund, value fund on an average five-six year return is in the same line between 13% to 15% amounting only, it's not as somebody has given some exceptional returns, but it compliments you, the overall portfolio return when your growth strategy is not being, so, that is how this entire portfolio approach is.
Nikhil, how important is that strike rate for an asset manager to hit on a consistent basis?
Nikhil Kothari: So, see the biggest problem in value funds is, it is very simple, you buy something at low price and then you sell at a higher price. On the face value it looks very easy, but the biggest problem in the value fund is the value trap.
You may see that this company has a good value, the price is low, and when the prices are low when the things happen there are headwinds in that industry or the company, either there is some problem with the profit-loss account or there is some problem in the industry as such in terms of growth of that industry.
So, there will be some problem at that point of time, which is to make sure that the prices come low and that stock or the industry is in value, but whether it will turn out or not, whether there is a problem management whether the problem is solved or not, or whether the industry headwind has been solved or not.
So, if that is not done, then it can fall into value trap and you may keep on buying that stock or keep on averaging the stock, but the stock can keep on going down because of the value trap. So, a fund manager has to be very clear when you are buying a value stock and not fall into a value trap. The second problem with this category of fund is, there can be severe underperformance for a very long period of time as compared to index.
So, most investors when they compare their portfolio, they will say okay, the index has given me x percentage this fund is unique by x percentage. Now the period of underperformance can pull on for two years, three years. At that time investors get impatient, and they sell this fund and that can be the answer in the main point that the fund can revive.
So, when investors investing in this fund, they have to understand that they can be a long period of underperformance as compared to index and the fund has to be very carefully in terms of identifying stocks, which are not a value trap but which are actually a value stock and then they can revive when the industry headwind changes and if those things are taking place, then the medium-term period, the individual can expect a good return in his portfolio.
While when selecting a fund there are few fund houses which are more biased towards value and there are few fund houses which are more biased towards growth. So, if you are selecting the fund, you can say that okay, this fund house follows the values type in the investment. If I want to go and select a fund, I can go and select a fund from that fund house a specific value fund. So, because the fund house follows a value strategy it is better to buy a value fund.
Kshitiz, how do you select that stock, and should you be okay with long periods where you are significantly underperforming not just the index but also peers.
Kshitiz Mahajan: So, that is why you see a fund’s approach is always better vis-a-vis selecting the individual stocks. That is why we say mutual fund and in mutual funds, all the value good funds, which are being fairly decent over a period of time and were bought on they are not that big.
You will see there is a good mix of PSU as well as private limited companies. PSUs as said by Nikhil, can have a long gestation sometimes. You have seen the entire banking system has gone through an overall change and we have a lot of recoveries coming, banking system is getting better. It has taken a lot of time except for SBI to come up the curve and perform.
So, similarly, the other PSU companies also vis-a-vis the private value companies will not take that time as a long gestation time. Sometimes it happens that the holding company has some news coming in. Again, whatever we are quoting here is not a recommendation.
A fund manager while selecting because we keep on interacting with all the key guys, the fund which we manage, for our portfolio, the success for our portfolios that how they are looking at the portfolios and what I can get from them, or I can draw from them is that they get into a larger number of chunk of stocks.
Some people have 60 stocks and the stocks in their portfolio, somebody will have more than thirty stocks in their portfolio because if there is a chance or risk of a value trap, then the rest should be less on the portfolio level.
One of the fund has almost twenty plus stocks which is less than 1%, so that the overall dent to the portfolio should be less, if it's a value trap, and very well agree with Nikhil that yes, value traps can be one of the cases where he can fall into that and you just see that, hopefully is going nowhere.
So, I think it's a good mix of PSU and private limited companies at the same time many companies which were growth companies because of some XYZ news, whether it's Covid or some industry specific news or what happened to I.T. sector or pharma sector has now become a value companies.
So, if you will keep this index, and I am not saying this will remain same for next two years, will become a value index in next two years’ time, if you will see that it was earlier growing at 12-13% also. So, we have to understand that that portfolio approach is always better, and I will have to go with a couple of value funds for clients, wherein I see diversification is there and an active management is there and a good combo of PSU and private limited companies.
Nikhil, if you can identify a few funds that you like.
Nikhil Kothari: We normally prefer when buying a value fund, the fund houses also to some extent follow a value strategy. From ICICI, Sankaran Naren is known for who can identify sectors which are underperforming now and which can revive or which he normally takes contra bets.
Many a times when you are investing in value fund, we normally prefer Templeton India value fund or ICICI value fund and over and above that Invesco in contra follow the very specific strategy where they have a very clear band in terms of every stock is classified either growth or value and they have in contra fund most of the stocks from the value category. So, these are funds we normally prefer when it comes to value or contra.
Kshitiz Mahajan: So, one of the fund I like what Nikhil is saying is Invesco contra and if you actually look at the top holding also HDFC Bank, Infosys, ICICI Bank and Reliance. So, if you actually see all these top holdings for this fund right now, they were growth stocks almost a year and a half back, which has become now value because prices have not moved up that much or let's say it's corrected from its peak. So, I think that's one of the strategies which has been consistent in its endeavour and very well diversified.
Second is, which strategy I like the most is SBI contra and again one of the key strategies in value play, which is banking very high on financials, which is banking very high on consumption staples, is doing really well. So that is another strategy which is doing well and very consistent in its approach also. So, in the last two and a half, three years had been for value play, which we have seen in 2020 when the market started recovering.
There is a lot of infusion of capital and then growth values started working and then growth value started playing. But then an investor investing is not investing for a year or two, but a consistent approach towards both strategies will help him to have a balance, or let's say, a less slowdown on overall portfolio because both of these strategies complement each other and that's the crux of the story.
What we want to give investor is experience where drawdowns are less, try to do that where we can suggest that we can complement his portfolio by adding value to overall growth strategy.