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 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.
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.
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).
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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