Value funds are outperforming but don't chase them yet, say experts

A safer approach is to invest in both value and growth style funds as performance alternates

Value funds are on the comeback. With a one-year category average return of 32.1 per cent, funds pursuing this style have beaten the 28.8 per cent return produced by flexi-cap funds (which have the freedom to invest anywhere) over the same period.

Earnings revival in value stocks

Over years, value-oriented sectors and stocks were ignored by the market due to lack of earnings growth and leveraged or stressed balance sheets. “After several years, earnings in many of these sectors and companies surprised investors last year. Their valuations were attractive relative to the rest of the market. This combination led to the sharp outperformance seen in value funds,” says Daylynn Pinto, senior fund manager-equity, IDFC Asset Management Company.

Sectors that contributed to these funds’ performance included commodities, which benefited from higher prices and deleveraging; building materials; real estate, where both demand and cash flows have improved; and some sectors in the mid- and small-cap segment like textiles and auto ancillaries.

Mid- and small-cap stocks were in the value zone after the huge underperformance witnessed from 2018 till March 2020’s fall. “A fund like ours that took exposure to them benefited,” says Pinto. IDFC Sterling Value Fund has outperformed others in the category over the past year with a return of 56.4 per cent.

Many value businesses, like infrastructure, are capital intensive. “With interest rates coming down, their cost of capital fell and profitability rose,” says Vaibhav Porwal, co-founder, Dezerv.

Public sector units (PSUs) are also regarded as value plays. “With the government appearing serious on divestment after its successful exit from Air India, there is renewed interest in PSU stocks,” says Porwal.

Invest for style diversification

After a strong rally in high-growth companies, the cyclical and value parts of the market move up. “It is impossible to predict when growth or value will do well. That is why investors need style diversification with exposure to both types of funds,” says Kaustubh Belapurkar, director-manager research, Morningstar Investment Adviser India.

In a normal inflationary environment (though not a hyper-inflationary environment), value sectors tend to outperform traditional growth sectors, which tend to do well in times of low inflation. “One way investors can hedge themselves against inflation is by taking some exposure to value funds,” says Pinto.

Prepare for bouts of underperformance

Returns from value funds come in bursts. “The value theme did well in 2016-17. In 2018-19, we saw a strong market for growth funds.  Value funds tend to have periods of underperformance due to which investors need to be patient when investing in them,” says Belapurkar.

Underperformance can occur if the fund manager invests in value traps. “Businesses that appear cheap can become cheaper due to deterioration in their fundamental attributes. Investing in such value traps can damage returns,” says Porwal.

Look for consistency

Go with fund managers who have consistently followed the value style. “Checking a fund’s style box over several years will tell whether the fund has followed the value style consistently,” says Belapurkar.

Compare the portfolio of a fund house’s flexi-cap and value fund. “A true-to-name value fund will have a different set of top 10 holdings than the flexi-cap fund from the same fund house. If their top 10 holdings are the same, one of the funds is not being true-to-label,” says Pinto.

SIP to benefit from volatility

Invest in value funds with at least a five-year horizon. Volatility can, to some extent, be higher in these funds than in a flexi-cap fund. “SIP is a good strategy to straddle this volatility and benefit from it,” says Pinto.

Avoid going overweight on either the value or the growth style based on recent performance. “You would probably enter the fund late in the cycle. If the cycle turns, you could be stuck with an overweight position in a style that may have done well recently but could underperform in the near future,” says Belapurkar.

Value funds have outperformed over past year

Category	1 Year	3 Years	5 Years
Value funds	32.1	15.8	15
Flexi-cap funds	28.8	17.9	16.9