Why Value Funds Are A Must In A Balanced Portfolio

You should have a horizon of 5-7 years and limit allocation to 15- 20% of your equity portfolio

The Sensex has bounced back 20.78 per cent over the past three months. The value fund category, which has been underperforming for a long time, has also risen 16.3 per cent on average, sparking hopes it may be poised for a rebound. Investors are asking whether the rally in these funds will sustain and if this is a good time to take exposure to the category.

Value funds have narrowed down the performance gap vis-à-vis their growth peers in recent times. “The gap between value and growth funds narrowed, both during the fall and the bounce-back over the past few months. These funds have begun to outperform globally,” says Nilesh D Shetty, associate fund manager-equity, Quantum Mutual Fund, who co-manages Quantum Long-Term Equity Value Fund.

The value category has underperformed for the past five years in India and for a decade globally. But that has also made value stocks much cheaper today than growth stocks. At some point, the rotation of investment from growth to value is bound to happen. Historically, value funds tend to do well during the recovery phase.

According to experts, it may be too early to conclude that the recent bounce marks the start of a sustained recovery. “The rally needs to continue for longer and the category should outperform a benchmark like the BSE 100 by a decisive margin before one can conclude that the recovery will sustain,” says Arun Kumar, head of research, FundsIndia.

Some experts believe investors should stay away from value funds for now. “Cyclical stocks, like commodities, are considered a part of the value segment. Commodity demand has taken a severe beating since 2011 and there is excess capacity globally. Similarly, power utilities are struggling due to poor collections. These industries are in survival mode, so they can’t offer healthy returns,” says Rajesh Cheruvu, chief investment officer, Validus Wealth.

Cheruvu adds that the polarised earnings have led to polarised returns, making healthy businesses stronger as they consolidated market share. Weaker businesses, with relatively higher debt or working capital requirement in the same segments, are trading at multiples that make them appear like value buys. But such businesses have been going through tough times and have been looking for opportunities to deleverage over the past five-seven years.

Due to these factors, he does not see the value segment doing well for the next few years.

Despite the category’s past underperformance, experts feel it has a place in the investor’s portfolio. “It is a valid, proven style. It has done well over longer periods of time. Value funds tend to do well when growth funds are underperforming, so allocation to them is advisable in a balanced portfolio,” says Shetty. Value funds also tend to provide better downside protection during a correction.

Kumar suggests holding value funds as part of a diversified equity portfolio consisting of five baskets — global, mid- and small-cap, value, quality growth, and growth at a reasonable price. Allocation to these funds should not exceed 15-20 per cent of the equity portfolio.

If the underperformance in value funds continues for longer, a higher allocation could cause pain. Investors with a five-seven-year horizon may enter these funds, as the category is certain to see mean reversion over that horizon. Stagger entry by adopting the systematic investment plan mode.

While selecting a value fund, go with a fund manager who has been handling this style for a long time. Such a fund manager would have a track record and will hence be able to withstand the pressure to dilute his style (which arises during a prolonged phase of underperformance) better than a rookie.