Passive value funds are for investors who can face deep drawdowns

Opt for passive funds to reduce fund manager risk and capitalise on their lower costs

The value style of investing has done well in the past few years. To capitalise on this performance, fund houses are on a fund-launching spree. While Axis and Bandhan Asset Management Company (AMC) have announced schemes tracking the Nifty500 Value 50 Index, ICICI Prudential AMC has launched new fund offers (NFOs) for both an index fund and an exchange-traded fund (ETF) tracking the Nifty 200 Value 30 Index.

Spotting undervalued stocks

Value funds invest in undervalued stocks across sectors and benefit from price appreciation when the market eventually recognises their true worth. “The cornerstone of value investing is the belief that stocks trading below their intrinsic worth, or ‘undervalued’ ones, often outperform the broader market over time. Value stocks are those that are out of favour, selling for low prices relative to their book value, a measure of net worth. They are at the opposite end of the spectrum from growth stocks,” says Sirshendu Basu, head, products, Bandhan AMC.

 

Besides actively managed funds, fund houses today offer a range of passively managed schemes tracking value indices. These schemes replicate the performance of the underlying index (after accounting for tracking error). Passive schemes that track indices such as the Nifty 50 Value 20, Nifty 500 Value 50, and BSE Enhanced Value have been around for some time.

Index construction strategies

Value indices consist of stocks that score high on a set of predetermined quantitative factors. “Value-oriented indices are constituted to invest in companies trading at attractive valuations. Most value indices consider price-to-earnings, price-to-book value, price-to-sales, and dividend yield ratio when screening companies,” says Sharwan Kumar Goyal, fund manager and head, passive, arbitrage, and quant strategies, UTI AMC.

Rule-based approach

Passive schemes that offer value-focused portfolios are cost-efficient. They are also rules-driven, eliminating the risk of poor decisions by fund managers. “Passive value investing has a clearly articulated rule-based approach to stock selection that eliminates the probability of misjudgement in assessing qualitative metrics. The low-cost benefit of passive investing adds another layer of potential outperformance to this investment style,” says Vandana Trivedi, head, institutional business and passives, Axis AMC.

Spells of underperformance

In a broad-based market rally, these index funds can often outperform actively managed ones. However, in times when stock markets consolidate and stock-specific movements occur, actively managed schemes may hold an edge.

“As with any other strategy, value goes through periods of underperformance, particularly during bear markets,” says Trivedi.

This strategy is relatively cyclical and has higher volatility. “Investors may experience relatively larger drawdowns during market corrections,” says Goyal.

Style balance

Since the majority of funds in India tend to be growth-oriented, investors should have some exposure to the value strategy for greater balance in their portfolios. They are suited for investors with a long-term perspective, ideally three to five years.

“Value index funds are most appropriate for long-term investors who can withstand deeper drawdowns. Investors may consider allocating 10-30 per cent of their total equity portfolio to value funds, depending on their risk tolerance and investment horizon,” says Basu.

Trivedi suggests adding value funds to the core portfolio.

Finally, Goyal suggests using the Systematic Investment Plan (SIP) route as the value style tends to be relatively more volatile.