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These funds need to deliver more value

June 14, 2006 13:05 IST
Having already explored the category of dividend yield funds in our series on mutual fund categories, we now focus on value funds.

Value funds are diversified equity funds, which pursue the value style of investing. Simply put, it involves identifying fundamentally sound stocks that are trading at a discount to their fair value. Usually the fund manager buys these stocks and holds them until the mis-pricing in the stock value gets corrected.

Value style of investing can work particularly well during a bear phase in the stock market when the fund manager has more opportunities to identify stocks trading at discount to their fair value. Value funds can make the most of their investments and pitch in a superior performance vis-à-vis their growth-styled peers in such an environment.

Value style of investing is normally associated with a longer than average investment horizon; in our view the ideal investment horizon for equities is at least 3 years, so investors must be prepared to hold on to their value funds for longer than that.

Although the first value fund was launched as early as 1996 (Templeton India Growth Fund) in the Indian context, the value fund segment is a niche one and there are just a handful of value funds in the country today. Also in India, you only have the concept of a value fund, unlike the US where you have an AMC (Asset Management Company) that can be classified as a 'value-style AMC' because it only has value-style funds (i.e. no growth-style funds or blended funds).

In India, apart from Franklin Templeton Mutual Fund, which was a pure value fund house until it bought over Franklin Resources Inc, you also have Quantum Mutual Fund.

With the stock markets at their volatile best, we thought that this would be a good time to review value funds and establish how they have fared against conventional diversified equity funds.

Value funds Vs Diversified Equity fund

NAV
(Rs)
Top 10
Stocks
(%)
1-Yr
(%)
3-Yr
(%)
5-Yr
(%)
Since
Incep.
(%)
Std.
Dev.
(%)
Sharpe
Ratio
(%)
Value Funds
DSP ML EQUITY 32.2 30.2 45.4 60.5 35.7 25.9 7.34 0.49
HDFC CAPITAL BUILDER (G) 48.9 44.8 28.3 58.7 38.5 23.8 7.64 0.42
UTI MASTER VALUE (G) 24.0 42.7 17.2 41.6 37.6 27.1 7.07 0.31
TEMPLETON INDIA GROWTH (D) 31.7 68.0 30.4 48.1 32.6 18.9 7.21 0.34
Diversified Equity Funds
HDFC TOP 200 (G) 80.6 43.7 45.6 55.8 41.8 32.3 6.62 0.47
PRINCIPAL GROWTH (G) 37.5 30.5 32.3 51.8 34.1 26.7 7.57 0.37
SUNDARAM GROWTH (G) 50.5 34.0 45.0 53.1 34.8 24.3 7.18 0.42
BSE Sensex 42.3 43.0 22.8
S&P CNX Nifty 35.4 39.6 20.5
(Data sourced from Credence Analytics. NAV data as on June 07, 2006. Growth over 1-Yr is compounded annualised. Top 10 stock holdings as on May 31, 2006.)

Portfolio Strategy
The investment universe of value funds spreads across market capitalisations i.e., from large cap to small cap stocks. At Personalfn, we believe that a diversified equity fund should hold no more than 40 per cent of its assets in the top 10 holdings; a top-heavy portfolio can make the fund a candidate for volatility during a downturn in markets. On this parameter most of the value funds under consideration would qualify as reasonably well-diversified.

Templeton India Growth Fund had the most concentrated portfolio with 68.0 per cent of its assets in the top 10 stocks, which is undoubtedly very high for a diversified equity fund. Other funds in this segment i.e. UTI Master Value (42.7 per cent) and HDFC Capital Builder (44.8 per cent) held reasonably well-diversified portfolios. DSP ML Equity Fund had the most well-diversified portfolio with only 30.2 per cent of assets in the top 10 stocks.

Performance
Over the 3-Yr time frame, the performance of value funds has been impressive. DSP ML Equity Fund with a return of 60.5 per cent CAGR over 3-Yr is the best performing fund, followed closely by HDFC Capital Builder (58.7 per cent CAGR).

Both the funds have also been successful in outperforming the benchmark indices. Conversely, UTI Master Value (41.6 per cent CAGR) is found wanting on the returns parameter vis-à-vis its peers and index. The performances of value funds are comparable with those of their peers from the diversified equity funds.

Over 5-Yr period, value funds like HDFC Capital Builder (38.5 per cent CAGR), UTI Master Value (37.6 per cent CAGR), and DSP ML Equity (35.7 per cent CAGR) have delivered impressive performances; also, these funds have been successful in outperforming the benchmark indices. Yet again the performances of value funds are broadly in line with those of diversified equity funds.

The 12-Mth performances throw up a rather mixed picture. While DSP ML Equity (45.4 per cent) has clocked an impressive performance, others have disappointed and even failed to match their benchmark indices. Conversely, diversified equity funds have pitched in steady performances.

Volatility & risk-adjusted return
As is evident from the table, both value funds and diversified equity funds have pitched in similar performances on the volatility control and risk-adjusted return parameters.

This is slightly surprising, as one would expect value funds to fare better, at least in terms of volatility control. Value funds would typically invest in undervalued stocks and adopt a "buy and hold" strategy and wait for the stocks to unlock their potential value. Consequently, these funds are equipped to clock stable growth and score smartly on the volatility control front.

It would be safe to conclude that there isn't too much variation between the value funds and conventional diversified equity funds, in terms of their performance on the returns parameter. However, their inability to distinguish themselves on the risk-adjusted returns front vis-à-vis diversified equity funds is a disappointment.

In our view, investors can consider adding well-managed value funds to their portfolios, especially the ones with established track records. However, these funds must compliment conventional diversified equity funds, which should form the mainstay of the investors' portfolios.

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