Value Investing is a concept that was developed in the 1920s by Benjamin Graham, And over the years some of the most successful investors including Warren Buffet have used the principle of Value Investing to create enormous wealth. But Value Investing is not limited to individual investors, there are mutual funds that follow these principles and are called Value Funds.
Mr. Sonam Udasi, Senior Fund Manager, Tata AMC at the ‘Ask the Expert’ session helps us decode Value Investing and tells us how Value Funds use these principles to generate returns.
While most investors understand the categories like Large Cap funds, The same can’t be said about Value Funds. Can you talk about what Value Funds are and where and how they invest?
Udasi: In the layman language, value is something that is cheaper than its instrict value. So the cheapness can be because of two reasons from the valuation perspective. One from the historical valuation perspective. That is whether in terms of PE, or price to book, cashflow, EDIBTA etc has become cheaper than its historical value. The other set of values is an emerging sector or segment which is small but can have explosive growth. And that today is cheaper and valued but can become expensive over a period of time. In this context I would look at value, whether you are following a large, mid, small or any category this theme actually holds true. This is the fundamental principle of investing in any asset class. That is, you are trying to buy something that is cheaper than what it was and therefore at some point of time you will be able to make money out of it.
So value investing is about playing on a possible recovery of a stock value. Doesn’t that increase the risk. What if the recovery never happens? And if it happens, isn’t there an opportunity cost for all the time you wait for the stock to recover?
Udasi: Being cheap is the starting point of discovering value investing. It is not the end point. So you are right, whether the recovery comes or not. The best stocks or asset classes mean that you have a blend in value, where the concern will go away over a period of time. Value has the potential to become valuable. That is the crux of value investing. Value for the sake of value and understand what trends you have to look at. Say out of the 100 opportunities, possible only 10 are worth looking at. So you have to look very deep and it takes time. Anything that is worthwhile, that will prove to be valuable — the process takes time. This is true for any investing and not specific to value investing. It is true for all asset classes.
In India and globally, big companies are growing bigger. So as an investor wouldn’t you be better off investing and benefit from the growth? Because these companies will never be in the value zone.
Udasi: I would disagree with that. For example, about a year back or for that matter for a long period of time the largest chemical refiner company was a commodity company and therefore it was cheaper than the market. Therefore it was value. Now if you have followed the company, it has slowly moved on to become a telecom giant and a retail giant. So that was the best kind of value, that you were finding something cheap because it was trying to use that cashflow to grow. And it was large already. And in recent times, if you see, in the context of the biggest of the biggest IT companies, they are cheap today. And if the rebound is quicker, for example the virus etc goes away, then technology is here to stay and you can benefit from it. Value investing is not either or, that its only small or mid cap, it is within the context of what you have — large, mid or small — you should keep looking. The best combination is you have found a dominant company at a cheap price. And that is where the crux of value investing is.
If you look at the last 10 year return, value funds even after the recent corrections haven’t beaten the most popular equity fund categories. Why is that?
Udasi: Taking the example of our fund, I must say we run a pretty successful value fund and if you pit it against a 10-year return of any category of funds, we have done very well. Now what do you define as value? Value or cheapness is just the starting point. Then you have to go deeper to figure out which is the most valued fund and is worth chasing. And which are the values which will essentially become a value trap. The concern which will definitely come in, the niggling worry, that I would define as a value trap. But if the concern is going away over a period of time and the sector and company is cheaper, then you should go ahead and do it. That value has the potential to become valuable. Different categories of funds have been successful for following the blend of growth and value together. It is never only growth. From the investment perspective, the idea is to buy something cheaper than what it is. And only then you can create alpha over the benchmark.
What are the benefits that investors get from the value investing approach?
Udasi: The biggest advantage of value funds is it has no bias. It calls a spade a spade and goes for it. The no bias approach tends to do very well when the herd mentality thing follows. It tends to save you from possible mistakes if anything goes wrong.
How should one go about picking a value fund for one’s portfolio. And also what are the characteristics of a good value fund?
Udasi: In any category, one should look at the track record of the category. And value being a structured fund it follows a certain pattern and there is a strategy in place. It makes sense to look at the track record of that strategy and the longer you have the strategy and its track record it gives you the sense of how it has performed over the cycle. And if it has been able to beat the benchmark over a period of time, then the strategy is working. Also when you are investing in Value Funds, which has a defined scope, there is a certain discipline of investing. There is no biasness of portfolio managers of saying I will not do this sector, it just goes by that particular strategy. And if you are true to that mandate then over a period of time, you will tend to make more money.
What role do you say value funds play in one’s portfolio when it comes to asset allocation? And how much should one allocate in them?
Udasi: For any equity investments one needs to have a three to five year horizon. And when you are doing something around value you definitely need to have that kind of a horizon. Value tends to play out in the cycle and sometimes it is a little more volatile than other categories. It is early on in the trend. And by the time the seed becomes a plant, it takes a little more time. So you have to give it that time to workout itself. From the percentage perspective, it depends on the age profile etc. But I would say, it needs to be 15 to 20 percent of your overall equity allocation.
One does not follow a trend that most other funds do and it can be a good hedge to your other strategy. While others are doing their usual themes, this goes against the trend and tries to do something different.
Any last words on value investing?
Udasi: Give this strategy some time. If you do not give it time, you will tend to go out at the wrong time. If you are willing to give it time, these types of funds tend to do very well for your portfolio. We look at any equity asset class, as if this value will become valuable at some point. And we become wealthier at some point of time. This is the same way of creating value.
Originally published at https://www.etmoney.com.