'Equity investments can be volatile in the near term' | Economic Times

Value investing lost lots of its fans in India in the last few years as value funds have severely underperformed the market. However, value investing found its mojo this year as value funds bounced back on the back of a market rally. Shivani Bazaz of ETMutualFunds.com spoke to Sorbh Gupta, Fund manager-Equity, Quantum Mutual Fund, to find out what is in store for value investors. “Before we talk about last year’s good performance, we need to understand why the value strategy underperformed from 2017- 19,” says Sorbh Gupta. Edited interview.Many investors have given up on value funds in the last few years. Suddenly these funds delivered good returns. How do you view the scenario?Before we talk about last year’s good performance, we need to understand why the value strategy underperformed from 2017- 19. As economic growth slowed down in the last few years, a handful of companies managed to gain market share and show growth in their respective sectors. The markets assigned disproportionately high valuation to such companies, making the markets highly polarized. While some of these were good companies, high valuations left little margin safety. In the post pandemic economic recovery, the growth appears more broad based and cyclical sectors are doing well. Value strategy usually does well in such a scenario . The pandemic led correction in March 2020 also allowed value funds such as ours to buy some high quality companies at good valuation. This is also aiding performance of value funds. Quantum’s loyal investors seem to have stayed on despite everyone writing off value funds in the last two years. Looking back, how do you view the period?Right from the onset, we at Quantum have focused on unambiguous communication on traits of value style and environment where value funds and QLTEVF could possibly underperform in the near term. Also, how eventually over a period the performance catches up. Further, in all investor interaction, we have highlighted the importance of having a long term approach while investing in equities. This clear communication has ensured that most of our investors have clarity about ups and downs of investing in a value strategy. This is reflected in QLTEVF’s investor vintage of 3.5 years (among the best in the industry). Internally, We have used this time to tighten our research and investment process, ensure that they remain relevant with the structural changes in the external environment. We have also spent a lot of time dissecting our performance metrics to ensure we don’t underperform for the wrong reasons. The definition of value seems to vary from scheme to scheme. What are value funds and what can investors expect from these schemes? What should they watch out for?While SEBI has carved out a value category, It has not defined what construes value style. Simply speaking, value style practitioners look out for and invest in businesses which are available at below their fair value but have a measurable and time bound catalyst. The value funds are designed to prioritize capital preservation over capital appreciation and tend to outperform when risk is adequately priced. Investors could look for the following portfolio characteristics to decipher whether the fund is true to being value or not: P/E of the fund is consistently lower than the benchmark P/BV of the fund is consistently lower than the benchmark Dividend yield of the fund is consistently higher than the benchmark. You are betting heavily on the financial sector, technology, energy and automobiles. What is the strategy?QLTEVF portfolio is built by a robust bottom-up research on over 200 companies and sectoral weights are a bi-product of our investment process. Over the last few years we have found value in cyclicals names like large banks, specialized NBFC, Automobiles, PSUs & Tech ( global cyclical) & materials. In an economic recovery, cyclicals tend to see the highest earning upgrades. Some of the portfolio stocks are well placed to see value unlocking through a time bound catalyst as the macro tailwind plays out. We have also been stress testing the portfolio companies to ensure they have the balance-sheet strength to survive a macro shock due to Covid-19 third wave or global uncertainties. Investors have finally realized that value funds can be risky. What is your view? What should investors be careful about?Equity investments can be volatile in the near term as the intrinsic value of any investment is realized over a longer period of time. In Warren Buffet’s words “ Equity Markets are voting machines in the short term but weighing machines in the long term’. The real risk for a long term investor in the equity market is permanent loss of capital. This is what the value manager’s like us try to reduce by means of effective ‘margin of safety’ and applying a strong management integrity screen. Investors should understand the manager’s style and also the environment in which different styles could outperform or understand. Further, style diversification is also something we believe investors should actively contemplate while deciding their long term equity allocation. The market is at an all time high. Do you think you will find value in such an expensive market?Markets are heterogeneous. Not everything is cheap or expensive at the same time (barring times of severe global dislocation like October 2008 or March 2020). After the recent rally, the benchmark indices appear expensive. Though stocks with valuation comfort are not as easily available as was the case in March-April 2020, there are pockets of value in the broader market. Some of the financials including NBFCs are very well capitalized and have more than enough provisions to tide over the possible NPAs accretion due to second wave. They have a history of strong underwriting abilities, have decent low cost liability franchise and are still offering decent upsides. Some of the well managed consumer discretionary names in the auto sector with strong balance sheet & attractive return ratios also are available at good valuations. Some companies in IT & Pharma are poised to benefit from improving global economic recovery. They offer ‘good business & attractive valuation’ combination What is your view on the market? Do you think the RBI will continue to keep rates low?The economic and equity market recovery from the March-20 bottom has played out exactly as a leaf out of the economic textbook. And very similar to what happened immediately after the previous two economic down -cycles 2004-05 & 2009-10. Uptick in exports and quick improvement in sectors like residential real estate (strong GDP multiplier) & IT (largest creator of white-collar jobs) indicate economic expansion should continue leading to earning the upgrade for corporates. This should keep the equity markets in good stead. Growth in private capex and pick up in credit demand from corporates for capacity expansion will be very important metrics to track to further confirm the trend. RBI has resisted, raising interest rates despite inflation moving beyond its comfort level risking inflation becoming endemic. With the U.S Fed moving towards tighter liquidity, RBI will have to follow suit sooner than later. However, if the interest rate hikes happens after economy has found its feet and is done in a calibrated fashion (it will be dependent on inflation data), it should not spook the markets beyond few days of knee jerk reaction.