The value mutual funds category has seen an impressive 25-35 percent return in the last one year. This performance has been due to the much-awaited rally in value stocks over the last six-odd months.
Focused sector funds (technology and pharma categories) have generated 45-55 percent return in the last one year.
While these funds have done well in the recent past, they are not all-weather options for long term equity investors. Why? The two main reasons are cyclicality of returns and importance of timing. If you get these wrong, you can even end up losing a lot of money.
Value and contra funds
Both these investment styles rely on stock selection from that part of the market which is unnoticed for some time. In other words, the portfolios of such schemes have a large portion of stocks which are trading at a price below their calculated, assumed intrinsic value. Contra, some argue, is simply another name for a value strategy, but it also includes stocks of companies that are turning around
Over the last 2-3 years, value and contra picks got neglected, as growth stocks were favoured. As a result, funds that focused on value and contra stocks were underperformers, too. This has changed in the last few months, when once again the focus has shifted to the underpriced section of the market.
Also read: Could the year 2021 be the year for value funds?
With this recent price rise, it’s easy to forget that the wait for outperformance has been long. According to data from Valueresearch, the value category on the whole has underperformed the S&P BSE 100 in four of the last 10 calendar years; 2018-2020 was one such phase.
Some value fund managers have added growth-oriented stocks as well to the portfolio.
The value vs growth debate has now shifted slightly as the definition of value has expanded. Even those stocks with high earnings visibility, growth and high valuation get classified as value picks, as long as their current market price is below the assumed intrinsic value.
Rather than trying to figure out a fund manager’s value strategy and how far it is from being realized, individual investors may be better off investing in regular diversified equity portfolios that aren’t bound by restrictive mandates.
Sector and thematic funds
There are at least 11 different types of themes and sectors: from banking and financial services to FMCG and Environment-Social-Governance (ESG) funds. Today, the sector winners are technology and pharmaceutical funds, a few years ago, banking and financial funds led the way and in 2006-07, it was the newly launched infrastructure funds.
Most sector-based themes are cyclical in nature. They are subject to fluctuating business fortunes and/or the macroeconomic environment. Timing of entry and exit becomes critical.
Then there are themes that are so broad in their ambit – infrastructure and even ESG – that the portfolios tend to resemble the larger market indices. Thus, the choice of diversifying into these themes doesn’t really add much to incremental portfolio returns.
And monitoring market movements is critical. For example, the talk of Government disinvestment has meant that energy and PSU sector funds gained significantly in the last few months. The average returns from this segment in the last six months is around 20 percent, but three-year returns in these funds are negative or in single digits.
Equity funds which focus on a specific theme, sector or investment style tend to be risky. Also the portfolios may have unbalanced exposure to specific stocks in a sector which can cause undue volatility in returns.
While you may miss out on the above-average performance of some of these themes from time to time, the higher volatility doesn’t result in commensurately better overall returns even over a 5–10-year period.
If you wish to invest in equity for creating long-term wealth, then this kind of volatility may not help you in reaching your goals.