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Is it time to say goodbye to your Value funds?

Across time horizons of three, five, seven, and ten years, value funds have lagged in performance as compared to other equity fund categories. Does that make a strong case for exiting the value funds?

Value funds are equity funds that invest in stocks that are quoting below their intrinsic worth. Its investing style typically follows the value investing philosophy made famous by the legendary investor Benjamin Graham in the 1930s. 

After losing heavily in the market crash of the 1920s, Graham developed a safe investment approach that essentially involved owning stocks with ‘huge margin of safety’ or downside protection. 

Free Fall

However, in the recent market crash, value funds were unable to curtail the losses. In the last year, they were the worst performers among various categories of equity funds. they were down by 32 per cent while large-cap, midcap and multi-cap funds were down by 22 per cent, 25 per cent and 31 per cent respectively. 

Across time horizons of three, five, seven, and ten years, value funds have lagged in performance as compared to other equity fund categories. 

Does that make a strong case for exiting the value funds?
 
Historically, value and growth stocks in India have done well at different points in time. In six of the last 15 years, Nifty 500 Value 50 TR (Total Returns) outperformed the Nifty 500 TR. 

 
Cyclical nature
 
Value stock prices typically exhibit a cyclical behaviour with a significant correlation to the economic activity/cycle. This could be explained due to the presence of sectors of cyclical nature in its portfolio - financial services, metals and energy – that traditionally have carried a high weightage in its portfolio. 
 
Stock prices of such companies tend to recover sharply during the economic recovery and strong phases of economic growth. For instance, after the onset of the Global Financial Crisis, in 2009, they outperformed the broad market by a wide margin (42%). 
However, the price of value stocks has been consistently slipping in the last two years. In 2018, prices were down by 26 per cent as compared to a two per cent drop for the broad market. In 2019, when the broad market was up 9 per cent, it continued to post a negative return of 14 per cent. With a preference for quality ‘growth’ stocks increasing along with risk-averse investors, undervalued stocks that didn’t show up on current results were given a miss.
 
Value stock prices typically exhibit a cyclical behaviour with a significant correlation to the economic activity/cycle. This could be explained due to the presence of sectors of cyclical nature in its portfolio - financial services, metals and energy – that traditionally have carried a high weightage in its portfolio. 
 
Fund performance
 
In the last three years, none managed to outperform the broad market. And only two funds managed to give relatively higher returns than that of the broad market index (Nifty 500 TR) over a five-year period. 
 
Investment Approach
 
With the global economy now in a recession, with the spread of the Coronavirus, it will be a while before the tide turns. Indian economy which was already slowing down in growth is going to take some more time to come back to its normal growth trajectory. Recovery for Value funds, with its strong linkages to the economic cycle, if at all, is likely only in the distant future.
 
Moreover, financial experts are increasingly preferring to diversify portfolios across market capitalisations than among investment styles. Perhaps because the former is more well-defined. After all, what is ‘value’ for one, might be ‘growth’ for another. Also, with the classification of value funds termed loosely by Sebi (investing 65 per cent or more in value investing style), value funds tend to operate at different levels of risk. Some others don’t strictly follow the value investing style and have their own version.
 
As an investor, you are better off holding funds with clearly defined market capitalization orientation than the vaguely-defined value funds.
 
Takeaway
 
Value fund investors are better off diversifying their portfolio across market capitalization than among the vaguely-defined investing styles.
 

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