Can value continue to outperform? UTI MF's K Lakshmanan on the growth versus value debate

Karthikraj Lakshmanan, Fund Manager, UTI Mutual Fund

Post-pandemic value stocks have had a fantastic run on the bourses, while ‘quality’ stocks have been largely underperformers. Is it time for the tide to turn? Karthikraj Lakshmanan, Fund Manager, UTI Mutual Fund breaks down the drivers of value stocks in recent years and why the dream run may not continue.

What is the outlook for the markets?

In FY25 we are looking at 11% plus earnings growth as consensus for Nifty 50. In the previous decade from 2013-14 to the next 7-8 years, it was mid single digit earnings growth. The reason for that was, while the structural companies continued to compound, the cyclical businesses were underperforming. Some Companies from sectors like steel, automobiles, oil & gas and corporate banks had volatile earnings in the last decade and were not contributing while IT, a few private banks, FMCG, consumer durables and select pharma companies were contributing to the growth. Post Covid, the cyclical companies have turned around and contributed to the growth.

But now the valuations are definitely higher than long-term average. Because of that one has to be cautious of what is the current implied growth rate. While there are some pockets of opportunities, on a broader market level, there is a little stretch.

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How do you view the value and growth stocks. The value stocks have outperformed growth in the recent times? Will that continue?

If we take the quality index as a proxy for growth, typically there is a cyclic performance between value and quality or growth. There are few years where value does well then another few years where growth does well. These are the kind of cycles we have seen in the last 15 plus years. From 2021 we have seen value style doing well and growth has underperformed.

This cyclicality reverses at some point. But it's difficult to predict when. There are compounders (quality/growth) which broadly grow at steady pace over longer periods. On the other hand, there are some cyclical companies which will tend to have low profits or even losses when the tide is against them. When they rebound from there, the topline grows healthily due to favourable base, margins expand and there is high earnings growth. Often cyclicals are ‘value’ companies and they have been doing well. Will it continue that way going forward? It’s difficult to say. But eventually we need to look at mean reversion and implied growth. Three years back, the implied growth for the value names was achievable. But today, because of the high valuations, it doesn’t provide much comfort and their cyclical nature doesn’t go away on account of global, local or internal reasons.

Your views on the large, small and midcap performances?

When we look at valuations of large, mid and small cap companies, large caps are relatively more reasonable. Large caps are just getting into the expensive zone while mid and small caps have already crossed that a few months back. Large-cap are also slightly better when it comes to volatility. An investor may allocate some part of their portfolio to large cap depending on their risk profile. Considering the overall cohort of retail investors, large caps should be part of the core equity allocation due to its lesser volatility as compared to mid and small caps.

What is your strategy for generating alpha in the large-cap fund?

Alpha generation among large cap companies can be from few ways. One is many of the market participants may have a short-term focus and there we could identify companies which are very good from a longer-term perspective, but may be undervalued at this point in time due to near term pressure. Secondly, Competitive advantage itself is the biggest difference. Companies with strong competitive advantage in terms of brand, cost leadership, distribution network, technical know-how, etc may have better earnings visibility and sustainability. When there is a tough time, they will be the last man standing compared to competition and when the sector recovers they are better placed because they did not get hurt as much on the way down. So, the competitive advantage franchises eventually make better returns. Thirdly, companies with higher profitable growth than industry and economy tend to do well over longer term.

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Also, while the fund is mandated to have atleast 80% in large caps, that still leaves 10-15 percent room to invest in mid and small caps having certain competitive advantages. There is no change in the fundamental filtering. Some of them have the potential to become a large cap few years down the line, especially the midcaps which are on the border to become large-caps. There could be other companies which could be growing high on small base or could be sector leaders but mid/small by market capitalisation. We try to buy these and aim to generate wealth from a longer-term perspective.

What do you think of the AMC businesses?

The sector has grown handsomely in the last 10 years. The AUM of mutual funds have crossed Rs 50 lakh crores. But when you look at it as percentage of GDP, we are just ~15%, which is significantly lower as compared other large economies. Whether you take it in terms of number of unique folios which is over 4.20 crores, the penetration is still in single digits. So there is high scope for increasing participation in the mutual funds industry. The stock market doing well is one leg of the growth and the second is the inflows. Inflows can come from existing investors and new investors. People who enter the job market in the next 5-10 years will probably start their investments much earlier because of increased awareness and penetration. This is a high cash flow business as capital requirement is much lower. While the AUM increase would lead to fee reduction as a percentage of assets, considering there may be some room for operating leverage and absolute growth in profits could be healthy, the sector looks attractive.