Well-managed growth funds outperformed value funds in downturn Analytical contact: Krishnan Sitaraman Director CRISIL FundServices Email ksitaraman@crisil.com Irfan Rupani Senior Manager CRISIL FundServices Email irupani@crisil.com Executive Summary According to a CRISIL FundServices (CRISIL) study, covering the period January 1, 2008 to April 13, 2009 a number of growth funds have outperformed value funds. This is contrary to the popular belief that value funds hold out better during a market downturn because they invest in stocks typically at low valuations, which are in turn expected to lose less value in a market downturn. In the recent market downturn, it is the basics tenets of fund management like stock selection and market timing that have contributed to the performance of funds rather than investment style per se. This explains why growth funds have out-performed value funds in this period. Growth fund managers have been able to identify and invest in companies having good business prospects with committed management at optimal valuations more successfully than value fund managers. Further, as most value funds in India` are younger than their growth counterparts, they have faced a protracted market downturn for the first time. What are value funds? Value funds pursue the value style of investing which involves investing in companies that are trading at a discount to their book values. Due to this, it is natural to expect while investing in such stocks that the probability of losing value is lower than in the case of growth funds where the valuations of stocks at the time of investment would typically be much higher. If this principle holds true, then even when stock markets correct sharply, value funds should fall lower than growth funds. CRISIL FundServices 1
Value Style vs. Growth Style As opposed to the growth style of investing which typically involves investing in companies that are either fully valued or trading at a premium to their book values, value funds invest in companies that are trading at a discount to their book values. A value fund manager is said to have done his job well, if he invests in companies, which have a much higher intrinsic value vis-à-vis what the stock market is attributing to their share prices. The higher intrinsic value may be due to a number of reasons which may not have been fully recognized by the market at large - for example a committed management, good business prospects, valuable physical assets, etc. By investing in well-managed companies that are available at lower valuations, value funds invest in companies that are available cheap and typically remain invested until the share price of the company corrects upwards to achieve or exceed the book value. Such upward corrections, when they happen are by and large much higher than what is seen in the case of growth stocks. At the same time, since quite often the upward correction from the lower share price to a higher one could take time, the value style of investing inherently assumes two fundamental traits: a) A long-term investment horizon b) Lower portfolio churn Both the aforementioned traits must be examined relative to growth funds, where investments are usually made with a lower investment horizon and portfolios display a higher churn. However, it needs to be kept in mind that not all stocks which are trading at a discount to book value can be termed as value stocks. Some of the companies may actually have very bleak business prospects or suspect managements and the markets may be valuing them appropriately. If a value fund manager, by an error of judgment, invests in such companies, it is very likely that he may end up eroding his investments. Value fund managers need to be wary of such misjudgments. Dividend yield funds Another variant of the value style of investing is investing in high dividend yielding companies. The dividend yield of a company is calculated by dividing the dividend (per unit) by the stock price. Since the stock price is in the denominator, a lower stock price results in a higher dividend yield. By investing in companies with high dividend yields, the fund manager is also in a way investing in companies at lower valuations. This investment style resonates with the value style of investing. For the purpose of this study, we have also included dividend yield funds under the broad category of value funds. CRISIL FundServices 2
Are value funds faithful to the value style of investing? In theory, value funds must invest in companies that are trading at a discount to their book values. The moot point is how can investors ascertain that the fund manager is faithful to the value style of investing? This can be done in various ways. One of the ways is to compare the fund s Beta (which is a measure of the volatility of an investment s returns relative to the market) with that of other funds practicing the growth/blend (investing in a mix of both growth and value stocks) style of investing. The Beta of a value fund is expected to be significantly lower than that of a growth fund since value fund managers by nature are expected to invest largely in low Beta stocks as compared to growth fund managers, who invest mainly in high Beta stocks. This ultimately reflects in the Beta of their respective portfolios i.e. relatively higher Beta for growth funds and relatively lower Beta for value funds. For the study, we have applied the Beta parameter to ascertain if funds that claimed to be pursuing the value/dividend yield style of investing, as per the investment objective, were in fact doing so. The Beta was calculated over the period of the market downturn. Thus, the period for this study was taken from January 1, 2008 till April 13, 2009. It must be noted that the downturn persisted at the time of writing the article and the end date April 13, 2009 was merely the cut-off date for the data used in this study. For the purpose of the study, the value funds were compared against CRISIL~CPR 1 and CRISIL~CPR 2 ranked funds (which are very good and good performing funds respectively 1 ) from the large cap-oriented equity schemes and diversified equity schemes categories (most of which were following the growth philosophy as per their investment objectives). Collectively, the CRISIL~CPR 1 and CRISIL~CPR 2 schemes account for 30 per cent of the schemes covered in both these categories in the CRISIL~CPR universe. In all, we considered 11 value funds for the study. The growth funds in the study numbered 26, making the growth funds sample size more than twice that of value funds. CRISIL s analysis revealed that the value funds (including dividend yield funds) had lower Beta in general than the growth funds (See Table 1 and Table 2 below) lending credence to the fact that the former were by and large faithful to the value style of investing. Even the Standard Deviation (which is a measure of variance in returns, thereby capturing volatility) of the value funds in general was lower than growth funds. Again, this signified that value funds were by and large less volatile than growth funds, which is the way it should be. 1 CRISIL s Composite Performance Rankings (CRISIL~CPR) is a unique evaluation system that benchmarks a mutual fund s performance among its peers using a combination of return, risk and portfolio attributes. The CRISIL~CPR is published on a quarterly basis. Further details on the CRISIL~CPR can be obtained from www.crisil.com CRISIL FundServices 3
This analysis was carried out to ensure that the sample of funds used for the purpose of this study did qualify to be included in the respective categorizations considered value funds and growth funds. Table 1: Performance of Value Funds on Standard Deviation and Beta Value Funds Std. Dev. Beta Templeton India Growth Fund - Growth 40.4 % 0.79 ING Dividend Yield Fund Growth 40.5 % 0.74 Tata Equity PE Fund Growth 39.0 % 0.72 Quantum Long-Term Equity Fund - Growth 36.9 % 0.70 Tata Dividend Yield Fund Growth 39.1 % 0.70 ICICI Prudential Discovery Fund - Growth 39.6 % 0.70 UTI Dividend Yield Fund Growth 36.3 % 0.68 Fortis Dividend Yield Fund - Growth 36.6 % 0.65 UTI Master Value Fund Growth 37.9 % 0.64 Principal Dividend Yield Fund - Growth 35.5 % 0.63 Birla Sun Life Dividend Yield Plus - Growth 32.1 % 0.55 Maximum Value 40.5 % 0.79 Average Value 37.6 % 0.68 (Standard Deviation has been calculated by taking the square root of the sum of the squares of the dispersion in the daily returns of the mutual fund scheme from its mean return. Beta is calculated by taking the covariance of the daily return of the mutual fund scheme vis-à-vis that of the S&P CNX Nifty.) CRISIL FundServices 4
Table 2: Performance of Growth Funds on Standard Deviation and Beta Growth Funds Std. Dev. Beta ICICI Prudential Infrastructure Fund - Growth 48.5 % 0.96 Tata Infrastructure Fund Growth 45.0 % 0.89 Kotak Opportunities Growth 44.9 % 0.87 Canara Robeco Equity Diversified - Growth 44.1 % 0.86 Birla Sun Life Equity Fund - Growth 43.7 % 0.86 HDFC Top 200 Fund Growth 42.3 % 0.83 Kotak 30 Growth 41.6 % 0.83 DWS Alpha Equity Fund Growth 41.7 % 0.82 Birla Sun Life Frontline Equity Fund - Growth 41.3 % 0.82 SBI Magnum Sector Umbrella - Contra - Growth 41.9 % 0.82 DWS Investment Opportunity Fund - Growth 41.9 % 0.81 Reliance Regular Savings Fund Equity - Growth 41.7 % 0.79 Sundaram BNP Paribas Select Focus - Growth 40.0 % 0.78 Fidelity Equity Fund Growth 39.2 % 0.77 ICICI Prudential Dynamic Plan - Growth 39.3 % 0.77 Franklin India Prima Plus Growth 38.9 % 0.76 HDFC Growth Fund Growth 38.7 % 0.76 HSBC Equity Fund Growth 37.7 % 0.75 DSP BlackRock Top 100 Equity Fund - Growth 36.8 % 0.73 UTI Contra Fund Growth 37.6 % 0.72 Kotak Contra Growth 37.7 % 0.72 UTI Opportunities Fund Growth 37.3 % 0.71 Reliance Growth Fund Growth 37.8 % 0.71 SBI Magnum Multiplier Plus 1993 - Growth 37.4 % 0.69 Reliance Equity Fund Growth 35.6 % 0.69 DSP BlackRock Equity Fund - Growth 34.9 % 0.66 Maximum Value 48.5 % 0.96 Average Value 40.3 % 0.78 Growth funds outperformed value funds in the recent downturn The results of our study show that with some exceptions, performance of the well-managed growth funds in the most recent downturn (taken as January 1, 2008 to April 13, 2009 for the period of this study) has been better than value funds. Chart 1 below shows how a Rs 100 investment in the Value Funds and Growth Funds from the CRISIL study has performed since the downturn began. Rs 100 invested at the start of the downturn in Value Funds and Growth Funds declined to Rs 54.8 and Rs 55.3 respectively. CRISIL FundServices 5
Chart 1 Movement in Investment in Value Funds Vs Growth Funds 110.0 90.0 Value Funds Growth Funds 70.0 50.0 30.0 Dec-07 Feb-08 Apr-08 Jun-08 Aug-08 Oct-08 Dec-08 Feb-09 Apr-09 We considered the 20 worst performers in terms of returns out of the 37 funds across growth and value categories. Of the 20 funds, seven belong to the value funds category. In other words, 64 per cent of the value funds considered for the study formed part of the bottom 54 per cent (i.e. 20 worst performers) of the overall universe for the study (See Table 3 below). Further, the average returns of growth funds for this period was -46.8 per cent which was again better than the -47.3 per cent given by the value funds, while normally one would have expected the value funds to have outperformed the growth funds in the downturn. The percentage of growth funds and value funds outperforming the S&P CNX Nifty is comparable, although the performance of growth funds must be viewed from the perspective of a larger sample size in comparison with value funds. Table 3: Comparative performance of Growth Funds and Value Funds Percentage of Value funds sample among 20 worst performers 64.0% Percentage of Growth funds sample among 20 worst performers 50.0% Average returns given by entire universe -47.0% Average returns given by the growth funds universe -46.8% Average returns given by the value funds universe -47.3% S&P CNX Nifty returns for the period -45.0% CRISIL FundServices 6
Value stocks outperformed growth stocks in downturn Ironically, while value funds generally underperformed well-managed growth funds in the downturn, value stocks outperformed growth stocks over the same period. This was in line with the convention of the value style outperforming the growth style in a market downturn. This is apparent from the performance of MSCI India Value Index vis-à-vis MSCI India Growth Index. The graph below (Chart 2) reveals how a Rs 100 investment in MSCI India Value Index and MSCI India Growth Index has performed over the downturn. Rs 100 invested at the start of the downturn in MSCI India Value Index and MSCI India Growth Index declined to Rs 45.4 and Rs 36.5 respectively. Compare this with the performance of value funds and growth funds in the CRISIL study. The disparities in the relative performance of value funds vis-à-vis growth funds on the one hand and value stocks vis-à-vis growth stocks on the other hand are unmistakable. This is something for value style fund managers to consider when they evaluate their own underperformance in relation to the well-managed growth funds in the backdrop of the outperformance of MSCI India Value Index vis-à-vis MSCI India Growth Index. Chart 2 Movement in Investment in Value Stocks Vs Growth Stocks 110.0 90.0 MSCI India Value Index MSCI India Growth Index 70.0 50.0 30.0 10.0 Dec-07 Feb-08 Apr-08 Jun-08 Aug-08 Oct-08 Dec-08 Feb-09 Apr-09 (Source: MSCI Barra) CRISIL FundServices 7
Conclusion The following points come out clearly from the study: 1) By and large, value funds do pursue the value style of investing, a fact borne out by their lower Beta relative to the growth funds. 2) At the same time, this has not enabled them to outperform well-managed growth funds during the downturn. 3) However, value stocks have outperformed growth stocks over the downturn period. 4) There are growth funds and value funds that have performed well in the downturn lending credence to the view that prudent fund management and stock selection are critical and not only the style bias per se. This is something that investors should keep in mind while making their investment decisions. About CRISIL FundServices CRISIL FundServices is India s leading provider of fund evaluation and risk solutions to the Indian Mutual Fund industry. Widely acknowledged as the industry standard, CRISIL FundServices is the official provider of valuation tools and market benchmarks. Through its innovative analytics, benchmarks and analytical tools, CRISIL FundServices has played a significant role in shaping investor confidence and facilitating the introduction of best practices in the Mutual Fund industry. Disclaimer CRISIL has taken due care and caution in preparing this report. Information has been obtained by CRISIL from sources which it considers reliable. However, CRISIL does not guarantee the accuracy, adequacy or completeness of any information and is not responsible for any errors in transmission and especially states that it has no financial liability whatsoever to the subscribers/ users/ transmitters/ distributors of this report. No part of this report may be reproduced in any form or any means without permission of the publisher. Contents may be used by news media with due credit to CRISIL. CRISIL. All Rights Reserved. Contact Details: CRISIL FundServices, CRISIL Limited, 1021, Solitare Corporate Park, Andheri-Ghatkopar Link Road, Mumbai - 400 093 Tel: +91-22-4097 8000 Fax: +91-22-4097 8080 www.crisil.com CRISIL FundServices 8