Why a Market Crash May Be an Opportune Time to Look At Value Funds

Mar 23, 2020

Sixteen years in the financial services industry -- as an ardent market observer and a research analyst -- I have not seen this kind of heightened market volatility and sharp price correction barely in a span of two months since the peak of the S&P BSE Sensex (made on January 20, 2020).

The Coronavirus or COVID-19 that is declared as a global pandemic has left the equity markets across the globe panting for breath.

The benchmark index has fallen like ninepins -- nosedived nearly 30%.










 

Table 1: The value-buying opportunity

Particulars S&P BSE SENSEX S&P BSE Mid-Cap S&P BSE Small-Cap
All-time high (Dates) 20-Jan-20 09-Jan-18 15-Jan-18
All-time high level (in points) 42,273.87 18,321.37 20,183.45
Level as of Jan 1, 2020 (in points) 41,306.02 14,998.63 13,786.69
Level as of March 20, 2020 (in points) 29,915.96 11,141.38 10,113.36
YTD Return (%) -27.6% -25.7% -26.6%
Correction since the all-time high (%) -29.2% -39.2% -49.9%
Last updated on March 20, 2020
(Source: bseindia.com, PersonalFN Research)

Even during the global financial crisis of 2008, of course, the equity markets fell, but it was in phases (time-wise) and its pace got accelerated only towards the end. However, this time it's different, in the true sense.

Here's something to cheer for...

While there is no respite from the Coronavirus outbreak, the market valuations have now started looking rather attractive. The trailing 12-month P/E of the S&P BSE Sensex has cooled off from the high of 26x and is currently around 18x. Likewise, the S&P BSE Mid-cap and S&P BSE Small-cap Indices are attractively placed valuation-wise -- much lower than the levels recorded in 2017 and 2018.

I believe, it is an opportune time to invest in equity mutual funds that follow a 'value style of investing', popularly known as Value Funds.

Image source: unsplash.com; photo courtesy: Chris Liverani
 

What is value investing?

My observation is that in the stock markets the term value investing is commonly used but not everyone follows its true sense and spirit. It is quite customary to look at the 'price' than the 'value' a stock commands. People chase momentum, but what they forget to assess is the margin of safety and the value proposition.

Value Investing finds its place in the profound quote, "Beauty lies in the eyes of the beholder".

Value Investing is predominantly guided by its fundamentals. A variety of tangible and intangible factors are involved, and hence finding the true value of a company is extremely important. Buying companies which are available at a huge discount to their true value is the foundation of value investing.

That said, merely buying low and selling high (any or every stock) is not value investing either. There ought to be:

  • A reasonable margin of safety

  • The potential to earn a profit, despite volatility

  • And at times taking a smart contrarian bet

Discovering the true value is important for investing.

Here are 4 steps to value investing:

Step #1: Understand the business before buying a stock

"Never invest in a business you cannot understand." - Warren Buffett

If you want to follow the value investing approach, it's imperative to thoroughly understand the business. Unless you understand the business, you can't evaluate it on qualitative and quantitative parameters.

You would appreciate, before you make any judgment about how overvalued or undervalued a company is, you must understand the nitty-gritty of its business-its market, product range, pricing power, competitors, etc.

Step #2: Search for a wider 'economic moat'

Value investors always prefer companies with a high sustainable competitive advantage. Larger the advantage, wider is the economic moat. This moat would protect the business from the competition. And if the company is able to use its competitive advantage to widen the moat over time, then it is the perfect business to be in.

A wider economic moat not only helps the business earn superior returns for its shareholders but also helps get through turbulent economic phases.

Step #3: Efficiency of management

This is one of the most important factors because the management steers the company. But assessing the management of a company is not easy, as it is a qualitative aspect. No number can be assigned to it. That said, here's how one can broadly assess managements:

  • How prudently the capital deployed

  • How minority shareholders are treated

  • Financial results

Step #4: Valuations

Under this, we evaluate the quantitative aspects. So, typically factors such as Price-to-Equity (P/E), Price-to-Book Value (P/BV), the net-worth, Return on Equity (RoE), Return on Capital Employed (RoCE), the operating leverage, the debt-to-equity, dividend payout, dividend yield, forecasting future cash-flows, among a host of other parameters to make a worthy investment decision.

Nonetheless, the evaluation should not be taken in silos; but by doing a year-on-year comparative analysis, a peer comparison included, sector analysis, etc. to know if the stock truly justifies the valuations as of a particular date and if there is growth potential.

Time to invest in Value Funds?

The shrilling fall of the Indian equity market (and across the globe), has placed many stocks at mouth-watering levels. And with valuations looking attractive, the margin of safety opens the door of opportunities for fund manager of Value Funds.

As Value Funds are required to follow the principles of value investing and invest at least 65% of their Assets Under Management (AUM) in equity and equity-related instrument, as per the regulatory guidelines. In my view, fund managers of Value Funds will find opportunities across market capitalisations and sectors with a bottom-up approach.

Has their performance been satisfactory so far?

Over the past few years with economic growth slowing down, Value Funds haven't fared great - in fact, these funds have eroded investors' wealth over the 1-yr and 3-yr time frame.

But over longer time frames, over 7 years or more, certain Value Funds have done reasonably well. Value Funds tend to do better over the long-term. And as I mentioned earlier, it is opportune time to invest in Value Funds now.

Table 2: Report card of Value Funds

Returns (Abs %) Return (CAGR %)
Scheme Name 1 Year 3 Years 5 Years 7 Years
JM Value Fund -18.97 -1.53 4.82 12.09
Tata Equity P/E Fund -24.16 -3.03 3.39 12.87
L&T India Value Fund(G) -25.75 -5.05 2.90 13.28
Nippon India Value Fund -24.02 -2.06 1.88 10.19
HDFC Capital Builder Value Fund -33.03 -5.53 0.78 9.34
UTI Value Opp Fund -19.90 -0.90 0.34 7.90
Quantum Long Term Equity Value Fund -30.90 -7.38 0.02 6.74
ICICI Pru Value Discovery Fund -25.21 -5.49 -0.41 11.51
Templeton India Value Fund -34.37 -9.08 -1.25 6.04
Aditya Birla SL Pure Value Fund -34.52 -11.78 -1.31 11.35
IDFC Sterling Value Fund -35.02 -7.33 -1.38 8.54
Union Value Discovery Fund -25.21 - - -
Indiabulls Value Fund -24.64 -9.81 - -
IDBI Long Term Value Fund -21.81 - - -
S&P BSE 500 - TRI -23.98 -1.94 1.69 8.38
Point-to-point returns considered
Data as on March 20, 2020
(Source: ACE MF, PersonalFN Research)
 

It is important to choose Value Funds based on a host of quantitative and qualitative parameters. Plus, understanding the investment process & systems of the fund house would help. A sound and holistic approach in the research processes is essential for it to be a rewarding experience.

Watch out for risks too...

Value Funds is not for the faint-hearted. Before you consider investing, ensure you have a high-risk appetite and an investment time horizon of over 5 years. A Value Fund should occupy a portion of the Core Portfolio. The other types of funds in the Core Portfolio can be a large-cap fund and multi-cap fund.

Your Satellite Portfolio, on the other hand, can consist of a mid-cap fund, large & mid-cap fund, and an aggressive hybrid fund.

If you wish to invest in a readymade portfolio of top recommended equity mutual funds based on the 'Core & Satellite' approach to investing, I recommend that you subscribe to PersonalFN's Premium Report, "The Strategic Funds Portfolio For 2025 (2020 Edition)".

This premium report will help you build your optimum mutual funds portfolio for 2025 without any effort on your part. If you haven't subscribed yet, do it now!

Happy Investing!

 

Warm Regards,
Rounaq Neroy
Editor, Daily Wealth Letter




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