On a Treasure Hunt
“The most common cause of low prices is pessimism – sometimes pervasive, sometimes specific to a company or industry. We want to do business in such an environment, not because we like pessimism but because we like the prices it produces.” – Warren Buffett
The Fund
The above sums up value investing for you. The new fund on offer from ICICI Prudential AMC – ICICI Pru Value Fund – Series 1 (ICICI Pru Value) seeks to do just that. The fund will be a three-year close –ended equity scheme (which will automatically become open-ended after the lock-in period thanks to our reader Paresh who pointed out that the fund has a fixed maturity period. Investors have the option to choose a switch to another fund or receive an automatic payout at the end of the tenure) that seeks to exploit temporary valuation gaps in companies that otherwise enjoy sound business fundamentals.
It will use the value investment philosophy to pick stocks and also lock into profits either by selling such equities, or using derivatives. The fund only has a dividend payout facility. Investors will therefore have to prudently reinvest the payouts to build wealth.
The close-ended nature of the fund will allow it to take focused bets in stocks, likely with a mid and small-cap focus (which is where value often lies), without having to deal with constant flows of money in/out, at least in the initial years.
Investors may recollect that funds such as HDFC Mid-Cap Opportunities chose a similar three-year close-ended approach, which provided the fund a sound base to start with.
Yet, investing in close-ended funds effectively mean timing your entry, as you will be unable to do SIPs for 3 years. So the primary question to ask yourselves would be whether this is a good time to invest to seek value.
Value Investing
With markets closer to their all-time highs, you might wonder where the value lies. But slicing the market into segments would provide some vital clues.
1. Valuation Gap – There is a huge polarization of valuations between cyclical stocks and defensives. While defensives (such as FMCG, pharma, IT) have traditionally commanded a premium, valuations converge during peak markets and open up a huge gap during volatile/down markets. Since 2010, defensive stocks have mostly traded at over 20 times their Price to Earnings Ratio (much higher for FMCG), even as cyclical stocks have struggled hard to keep above 10 times and hardly moved over 15 times.
Clearly, if we do think we are closer to a market peak, this gap should have converged. Also, this does not mean all cyclical stocks are bad. There could simply be temporarily mis-priced opportunities in reasonably stable companies. Such value offers an opportunity.
This could be the case even in large-cap stocks. Investors who bought into the Bharti Airtel stock in 2012, when the stock corrected sharply on regulatory issues and competition, would have raked in gains in the later part of the year.
2. Mid-caps Lag – Traditionally, mid-cap stocks trade at a marginal discount to large-cap peers, given the latter’s superior financial and business strengths. But again, such gaps narrow; and often times when mid-caps command valuations as much as the large-cap segment, it is a warning of a heated market. In January 2008, for instance, at market peak, both the Sensex and BSE Midcap indices were trading at 27-28 times their earnings. Today, closer to 21,000, the Sensex is at a trailing P/E of 17.6 and the BSE Midcap is at about 7 times!
The last time the BSE Midcap touched this level was during the 2009 lows. Also, the BSE Midcap index’ Price-to-Book Ratio is at 0.7 times; it was 1.3-1.4 times even in the 2009 lows. Evidently, the increase in book value did not see commensurate price movement.
- Besides, the valuations of the market being below their 10-year average, has led to the gap between market cap to GDP widening significantly since 2010 and is close to historical lows. This suggests that stock prices have not really kept pace with the nominal GDP growth, however nominal the growth may seem.
Suitability
While there can be quite a few other points favouring value investing, it is important to know that value investing is also about picking the right stocks and not just about picking cheap stocks. It is ultimately about intelligent investing and it may not pay off in the short term. It also requires great stock picking acumen. To this extent, investors have to rely on the fund manager’s skills and have great perseverance.
This is why value investing is suitable only if you have a long-term time frame. Funds such as ICICI Pru Discovery from the same stable have successfully adopted value investing strategies to gain, but have shown periods of underperformance in rallying markets such as 2007. Hence, it is important for you to be a patient investor.
Besides, a new fund and a lock-in period also means taking a big bet on the fund manager’s ability to take the right calls, without any track record to rely upon (ICICI Pru Discovery, was for a good part managed by Sankaran Naren, who is also a joint fund manager for ICICI Pru Value).
Peers
Not too many funds in the Indian context follow pure value strategies. Funds such as ICICI Pru Discovery, Templeton India Equity Income and dividend yield funds have done well in using value investing strategies, but give themselves the leeway to stray away from it, when required. PPFAS Long Term Value is an open-ended fund that has been around for less than 6 months and may therefore be less of a benchmark. Its portfolio has a good 20% in foreign equities and a generous dose of mid-caps.
We reckon ICICI Pru Value too will focus on mid and small-caps. While ICICI Pru Discovery does this too, it has a good third of its assets in large-cap stocks of over Rs 10,000 crore market cap. ICICI Pru Value is likely to also take more focused bets than its sister fund, given that the former has the comfort of a lock-in for a good while.
The fund will be managed by Sankaran Naren and Mittul Kalawadia. The fund’s NFO closes on October 28. It will not reopen for investment until after the lock-in.
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Great review. Thanks for that.
The interesting thing is – I cannot invest anything more than “play money” into the locked in value fund without opening myself to fund manager and timing risks. “Play money”, even with great CAGR for 3 years will net me only “play returns”.
So, overall, the locked in nature of the fund is mostly for the fund’s good, and not the investors’. I will probably wait for 3 years 🙂
dear Thejaswi,,
you are absolutely correct. i endorse your views
Will this be a good option for US residents from IRS taxation point of view? At maturity, how will IRS tax this? Will they tax it like a PFIC fund or regular LTCG?
Hi Vikas, ICICI Pru Mutual is one among a good number of mutual fund houses that do not offer schemes for NRIs residing in US/Canada. So this scheme is not available. Thanks, Vidya
Thanks Vidya. What happens when someone buys this fund before they become US resident and happen to be US residents when the fund matures?
Hi Vikas, In that situation, the fund can be held and the payout will be paid to the savings bank account linked at the time of sale. Fund houses typically do not force people out of a fund if they become ineligible mid-way. Tks.
Hi Vidya,
In this case what would be the taxation applicable in US?
Hello, for NRIs and residents, the Indian Income Tax Act does not tax equity funds held for over 1 year. You would have to check your local tax laws in the US for investing here. thanks, vidya
Would you know the reason for ICICI mf not catering to US residents?
This is not the case just with ICICI. A number of fund houses have this restriction not because of any Indian ruling but because of certain SEC restrictions on solicitation of business from US residents in case the AMCs have direct or indirect foreign presence. You may want to read this link on the fund houses that do not take investments from NRIs in US and Canada : http://pages.fundsindia.com/pages/faqs/do-nris-get-access-to-all-mutual-funds-what-are-the-funds-that-are-not-available-to-nris/
Tks, Vidya
Is it worth investing as I have sip in ICICI Pru Discovery fund of Rs 1600/-
Hi Sagar, being a new fund, whether it is worthy of investment cannot be judged through quantitative parameters. You have to take a call on whether you need a pure value fund (Discovery may not be called a pure value fund). thanks.
Then Discovery comes in Mid cap category.
Hi Sagar, yes it does. thanks
This fund have its own limitations.First its NOT going to be an open ended fund after completion of 3 years..unlike to HDFC mid cap opportunities u mentioned above and investors need to withdraw or shift to somewhere.after 03 years.can’t say whether period of 03 years is sufficient for any value fund to succeed.
Secondly,this fund do not offer growth option and only dividend payout means realizing the profits ..so considering this I think investors should prefer their Discovery fund (though their is exit load up to 03 yrs) than this NFO.
Hello Paresh, All close-ended equity schemes become open-ended after the lock-in period. So is the case with ICICI Pru value. Just that they will not be open ended after NFO period. Also, the idea of dividend payout only option is to give back profits occasionally, as the fund is close-ended. Thanks.
Thanks for your reply.
I think you need to confirm this from AMC..as far I have understood.. investors will get money back after completion of three years at prevailing NAV.
As well they have provided Switch option if investors wish to switch in any other scheme of ICICI-Pru.on maturity.
As far only dividend option is concerned ..I think they should have left it to investors ..whether Gr or dividend.
Regards.
Hi Paresh, thanks for sounding me off on this. Yes, the fund is 3-year fixed maturity plan. I shall correct this on the blog. Thanks again.
That’s one of the rare instances of an equity fund with fixed maturity!
As for dividend payout option, more reason why this should be a payout option, given the medium-term nature of the fund. Right now, given that value opportunities are available, the payoff may happen sooner than later. And if a market fall deprives investors of any such paper profits, there may be nothing at the end of 3 years. We have seen a year or 2 of rally and the gains entirely snatched away. That is the risk of equities in the medium term (less than 5 years). hence, to book profits as and when opportunities are made appears to be a sound strategy given the time period. Thanks, Vidya
Thanks vidyaji.
Though this fund have limitations I have already invested some lumpsum amount and have provided instructions to switch money in liquid fund on maturity.
Though market is close to Life Time High ,only selected stocks and sectors are driving market ..and I think there is good scope for value stocks considering next 03 years.
Rest all other aspects you have covered in your article.
Is this fund not available for UK residents, I can not find it using the mutual fund explorer onsite
Hello Samir, the fund is not open to US/Canada residents. However, if you logged into your account and could not find it under the MF investing section, I shall ask my support team to check on this and mail you. Thanks, Vidya
[With slight edits – moderator]
What!?! They have now launched Series 2 – NFO from Nov. 18th to 30th. Going this way, they can launch as many closed end equity funds as they want? I am feeling a bit “cheated”.
-T
This is a market timing product and fundamentally it is impossible to time markets. In my view very risky product.
Vidya/Tejaswi/Ankur,
So do u think is this the right time to invest in icici prudential value fund series 2 or do u think its better to hold on.I am completely new to this mutual funds.So need advise from people like you.
Hello Sastry, we would not recommend NFOs for somebody new to mutual fund investing. If you have an active FundsIndia account, use the ‘Ask Advisor’ feature (click help tab to see this) and seek our advisors’ help to build a suitable portfolio for you. This service is available to all our customers without any charges. thanks, Vidya
This is a market timing product and fundamentally it is impossible to time markets. In my view very risky product.
Would you know the reason for ICICI mf not catering to US residents?
This is not the case just with ICICI. A number of fund houses have this restriction not because of any Indian ruling but because of certain SEC restrictions on solicitation of business from US residents in case the AMCs have direct or indirect foreign presence. You may want to read this link on the fund houses that do not take investments from NRIs in US and Canada : http://pages.fundsindia.com/pages/faqs/do-nris-get-access-to-all-mutual-funds-what-are-the-funds-that-are-not-available-to-nris/
Tks, Vidya
[With slight edits – moderator]
What!?! They have now launched Series 2 – NFO from Nov. 18th to 30th. Going this way, they can launch as many closed end equity funds as they want? I am feeling a bit “cheated”.
-T
Is this fund not available for UK residents, I can not find it using the mutual fund explorer onsite
Hello Samir, the fund is not open to US/Canada residents. However, if you logged into your account and could not find it under the MF investing section, I shall ask my support team to check on this and mail you. Thanks, Vidya
Is it worth investing as I have sip in ICICI Pru Discovery fund of Rs 1600/-
Hi Sagar, being a new fund, whether it is worthy of investment cannot be judged through quantitative parameters. You have to take a call on whether you need a pure value fund (Discovery may not be called a pure value fund). thanks.
Then Discovery comes in Mid cap category.
Hi Sagar, yes it does. thanks
Vidya/Tejaswi/Ankur,
So do u think is this the right time to invest in icici prudential value fund series 2 or do u think its better to hold on.I am completely new to this mutual funds.So need advise from people like you.
Hello Sastry, we would not recommend NFOs for somebody new to mutual fund investing. If you have an active FundsIndia account, use the ‘Ask Advisor’ feature (click help tab to see this) and seek our advisors’ help to build a suitable portfolio for you. This service is available to all our customers without any charges. thanks, Vidya
Great review. Thanks for that.
The interesting thing is – I cannot invest anything more than “play money” into the locked in value fund without opening myself to fund manager and timing risks. “Play money”, even with great CAGR for 3 years will net me only “play returns”.
So, overall, the locked in nature of the fund is mostly for the fund’s good, and not the investors’. I will probably wait for 3 years 🙂
dear Thejaswi,,
you are absolutely correct. i endorse your views
Will this be a good option for US residents from IRS taxation point of view? At maturity, how will IRS tax this? Will they tax it like a PFIC fund or regular LTCG?
Hi Vikas, ICICI Pru Mutual is one among a good number of mutual fund houses that do not offer schemes for NRIs residing in US/Canada. So this scheme is not available. Thanks, Vidya
Thanks Vidya. What happens when someone buys this fund before they become US resident and happen to be US residents when the fund matures?
Hi Vikas, In that situation, the fund can be held and the payout will be paid to the savings bank account linked at the time of sale. Fund houses typically do not force people out of a fund if they become ineligible mid-way. Tks.
Hi Vidya,
In this case what would be the taxation applicable in US?
Hello, for NRIs and residents, the Indian Income Tax Act does not tax equity funds held for over 1 year. You would have to check your local tax laws in the US for investing here. thanks, vidya
This fund have its own limitations.First its NOT going to be an open ended fund after completion of 3 years..unlike to HDFC mid cap opportunities u mentioned above and investors need to withdraw or shift to somewhere.after 03 years.can’t say whether period of 03 years is sufficient for any value fund to succeed.
Secondly,this fund do not offer growth option and only dividend payout means realizing the profits ..so considering this I think investors should prefer their Discovery fund (though their is exit load up to 03 yrs) than this NFO.
Hello Paresh, All close-ended equity schemes become open-ended after the lock-in period. So is the case with ICICI Pru value. Just that they will not be open ended after NFO period. Also, the idea of dividend payout only option is to give back profits occasionally, as the fund is close-ended. Thanks.
Thanks for your reply.
I think you need to confirm this from AMC..as far I have understood.. investors will get money back after completion of three years at prevailing NAV.
As well they have provided Switch option if investors wish to switch in any other scheme of ICICI-Pru.on maturity.
As far only dividend option is concerned ..I think they should have left it to investors ..whether Gr or dividend.
Regards.
Hi Paresh, thanks for sounding me off on this. Yes, the fund is 3-year fixed maturity plan. I shall correct this on the blog. Thanks again.
That’s one of the rare instances of an equity fund with fixed maturity!
As for dividend payout option, more reason why this should be a payout option, given the medium-term nature of the fund. Right now, given that value opportunities are available, the payoff may happen sooner than later. And if a market fall deprives investors of any such paper profits, there may be nothing at the end of 3 years. We have seen a year or 2 of rally and the gains entirely snatched away. That is the risk of equities in the medium term (less than 5 years). hence, to book profits as and when opportunities are made appears to be a sound strategy given the time period. Thanks, Vidya
Thanks vidyaji.
Though this fund have limitations I have already invested some lumpsum amount and have provided instructions to switch money in liquid fund on maturity.
Though market is close to Life Time High ,only selected stocks and sectors are driving market ..and I think there is good scope for value stocks considering next 03 years.
Rest all other aspects you have covered in your article.