Are value index funds worth a look?

'Value' investing has been the flavour of the past few seasons now, easily eclipsing its rival 'growth' in the post-Covid era.

The 'value' approach focuses on identifying undervalued stocks based on key metrics like Return on Capital Employed (ROCE), Price-to-Earnings (P/E) ratio, Price-to-Book (P/B) ratio and dividend yield.

And given the parallel rise of index funds, with them comprising a 16 per cent share in the market (as of October, 2024), there has been a growing interest in value-based index funds as well. So, let's understand them better.

Year-wise performance

Value-based indices identify stocks from the top 50, 200 and 500 Indian companies by market value. We looked at value indices' calendar-year performance against the stock market, represented by the BSE 500, and 'active' value funds to understand how they performed when value style was in favour as well as when it was not.

The Nifty 50 Value 20, with one-third of its portfolio allocated to the IT sector, has managed to outperform the BSE 500 in four out of six years. However, its heavy reliance on the IT sector and passive investment approach has caused it to lag active funds since 2022.

In contrast, the BSE Enhanced Value, Nifty 500 Value 50 and Nifty 200 Value 30 indices have demonstrated strong returns in 2024, outperforming the BSE 500 by about 9 per cent and staying ahead of most active value funds.

This marks a remarkable turnaround from 2019 and 2020.

The recent resurgence of these indices can be credited to their 60 per cent allocation to PSU (government-owned companies) stocks, while active funds have scaled back their PSU exposure from 17 per cent in December 2023 to 13 per cent currently.

This structural difference highlights the reasons for the divergence in relative performance between active and passive strategies.

Long-term performance

When it comes to long term performance, only the Nifty 50 Value 20 has consistently outperformed the broader BSE 500 index and value category based on daily five-year rolling returns.

The rest - BSE Enhanced Value, Nifty 500 Value 50 and Nifty 200 Value 30 - have struggled to make a significant impact.

We also compared their average five-year rolling performance against 14 value-focused active mutual funds that had sufficient history.

Eleven of 14 active funds beat BSE Enhanced Value Index and Nifty 500 Value 50.

However, only one active mutual fund could beat the Nifty 50 Value 20. That's because the Nifty 50 Value 20 index captures 91 per cent of the market's upside while limiting the downside to 75 per cent. This means the index performs well when the market is rising, and it offers better protection when the market is falling.

To sum up

Three of the four passive value indices - BSE Enhanced Value, Nifty 500 Value 50 and Nifty 200 Value 30 - can be avoided.

As for the Nifty 50 Value 20, while the long-term returns look good, 80 per cent of its portfolio is in just 10 large-cap stocks, which can be risky.

Also read: Three tax-efficient mutual funds for safe, short-term investors