Trend reversal: Growth, quality investing gain momentum, outdo value theme

In a falling interest rate scenario, impacts growth and quality stocks more positively, say experts

The equity market is witnessing a significant shift in investment preferences, as 'growth' and 'quality' themes regain traction, outpacing the 'value' theme.

This reversal is attributed to valuation comfort in quality and growth companies, coupled with the expected interest rate cycle reversal.

Quality and growth stocks in the NSE 500 index have delivered a median return of 13 per cent since June 1. On the other hand, non-quality and non-growth stocks have returned just 4 per cent, shows an analysis by PGIM India Mutual Fund (MF).

The asset manager defines 'growth' as companies that have seen average five-year annualised sales growth higher than their historical sales growth. Meanwhile, ‘quality' companies are those that have higher than average five-year historical return on equity (RoE).

Between April 2023 and May 2024, stocks that do not qualify as quality or growth had delivered 86 per cent median return. This compares to 50 per cent median growth in companies that qualify both as quality and growth.

SBI MF, the largest fund house, has also been highlighting the reversal in trend.

“As a style, quality has started to do well with the top quintiles on quality outperforming the bottom quintiles in August,” the fund house said in its latest fact sheet.

The fund house defines quality as stocks that have high RoE, low leverage and high consistency in earnings.

Money managers say the interest rate cycle has a bearing on performance of companies in these growth and value buckets.

“Companies which have a high growth expectation have relatively higher impact of interest rates, which means they have a higher duration. Thus, in a falling interest rate scenario, high growth plus high quality companies may get impacted much more positively than those with lower growth and lower quality,” said Vinay Paharia, chief investment officer (CIO), PGIM MF.

Typically, value stocks are those that have low price-to-earnings (PE) ratio mostly due to their low growth potential.

A large section of PSU stocks fall in this bracket.

“For the last three years, value has significantly beaten quality, which is a rare phenomenon in Indian markets. However, given the stretched valuations, relatively lower performance, and global macro uncertainty, quality is making a significant comeback in 2024. We expect this trend to continue in the short-to-medium term,” said Vineet Sachdeva,

entrepreneur partner - quantitative equity investing, Alpha Alternatives.

The value versus growth dynamics also has a bearing on fund houses as many of them stick to one style or the other. As a result, a shift in trend leads to major changes in the performance pecking order.

In recent times, several fund houses have tried to diversify their funds across styles. It is to ensure that not all of their funds struggle if their preferred investing style starts underperforming.

For example, Axis and HDFC MFs were known as growth and value fund houses, respectively. But they have now diversified to an extent.

The equity market is seeing major changes in other aspects as well, points out SBI MF.

“While at the headline index level, equities continue to do well, there appears to be a change in the underlying market complexion. For one, breadth has started to decline, as evinced in a declining proportion of BSE 500 stocks outperforming the index. Sectorally, too, defensive sectors such as consumer, tech and healthcare have started to outperform cyclical sectors such as capital goods, real estate and public sector undertakings (PSUs),” the fund house said.