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Scouting for Value

ICICI Prudential Discovery has been topping the performance charts

This article appeared in the 15 December - 14 January, 2009 edition of Mutual Fund Insight.

ICICI Prudential Discovery has been topping the performance charts. But would it be a smart investment? Only if you invest systematically and stay in for the long haul, fund manager Sankaran Naren tells Larissa Fernand.

•    If you find yourself in a situation where you are in the midst of a stock market bubble and you find no value picks in the market, what would be your strategy for this fund?

From my past experiences, I have seen that if there is a bubble, there would normally be certain sectors in the market which are still cheap, where you can find value. During the Tech bubble in 2000, there were select stocks across Steel, Automobiles and Cement, in short - the old economy, which were available at great prices. In 2007 Infrastructure boom, non-infrastructure sectors were cheap, such as Pharmaceuticals and Technology. A big boom will isolate a sector, but will result in a pocket of substantial undervaluation elsewhere. 

•    Is there a good time to invest in a value fund?

Theme funds in general are cyclical in nature. They deliver substantial out performance at times and underperform at certain other periods. Investors must have a long-term orientation or they need to systematically invest in the fund over a period of time. Investors in India have relatively less exposure to value themes. The present share of value investing funds is very low relative to the long term potential of the theme.

•    So now is not a good time to invest in ICICI Prudential Discovery because it’s a chart topper currently.

In 2007, I was vocal about the fact that it was a great time to get into the fund because value stocks underperformed. We continue to recommend investments in value themes like ICICI Prudential Discovery. The focus for investors should be to build their value allocation through a systematic investment plan over the long term and invest for the long term. This is a time to systematically invest in value. I recently told some investors to invest 1 per cent of their equity portfolio every month in a value fund to see the benefit five years from now.

•    In the past few years, ICICI Prudential Discovery has gone through severe bouts of underperformance. What’s your advice to investors?

Invest in a theme fund where the fund is run as per the theme. There will be ups and downs, but reversion to mean will take place which will always benefit the fund in the long term. We, therefore, want long-term investors in this fund. If you take a 5-year or 10-year view, value will outperform most other methods. But investors must stay loyal to the theme. Ditto for the fund manager. He too must stick by his conviction and stay loyal to the theme.

•    What was the reason for the outperformance in 2005 and the underperformance in 2007?

This fund was launched in August 2004. From then till May 2006, there was a mid-cap rally in the market where value stocks also participated. Hence the outperformance. From mid-2006 onwards, the infrastructure boom picked up. I ran the infrastructure fund the way it was meant to be run and this value fund according to its theme.

As a fund manager, I follow an investment process. Market movement and short term performance cannot be controlled. However, in the long term, performance follows systematic application of process. 

•    In 2008, the fall was very much in line with the category average. Was that not surprising since being a value offering the downside protection must be higher?

There will be moderate downside protection because the portfolio has both large-cap value stocks, which protect the downside, and mid cap value stocks also. 

•    Right now, what are you betting on?

Relatively speaking, the maximum value right now is in Telecom. October 2009 was the first month in which we picked up telecom stocks. We are also bullish on oil marketing companies.

•    How come you have banking stocks in your portfolio right now?

The exposure has reduced. Last year, when Banking underperformed, we had a relatively higher exposure. The stocks that are in the portfolio now are stocks with valuation attractiveness.

•    How important is a top down call in such a fund?

It’s not specifically a top down call. At various periods of time, different sectors are favoured or hated and investors react accordingly. The challenge is to act in reverse mode and look for value in those sectors that have underperformed.

•    What do you look for in a value stock?

I look at Price to Earnings (PE) trailing, Price to Book (PB) and Return on Equity (RoE) relative to PB. This will ensure that stocks do not become value traps. I also look at the trailing PE of the stock in line with the historic PE of the sector and lack of investor sentiment in a sector.

•    At one time you had 70+ stocks in this portfolio. Are you comfortable with such a large number of stocks?

That was quite a while back. I think a portfolio of 50 stocks would be ideal. The 2008 experience underscores the need for detailed research with due diligence which has reduced the number of stocks we hold. Our effort is to ensure that returns are optimised for our investors.