Do you think that a qualitative description is better than hard numbers? If you feel this way, we have made things easier for you by giving you a snapshot of your fund, worth more than a thousand numbers. This snapshot is the Value Research Fund Style (VRFS).
The collection of a number of stocks in a fund's portfolio gives it a distinct style. By understanding the characteristics of this portfolio we can conclude how the fund will behave. One way of doing this is by looking at individual parameters such as the fund's P/E ratio, P/B ratio, market capitalisation, etc. The problem with these measures is that they are absolute. In order to get an idea of what they mean, we need to draw a comparison. This requires that we have more numbers on hand so that an appropriate comparison can be made. But so many numbers can complicate matters.
The VRFS takes care of this problem by presenting a unified snapshot of how a fund's portfolio looks. This snapshot is a nine-grid matrix, which represents an equity fund in terms of its market capitalisation and valuation. Market cap refers to the total value of all the shares of a company. Larger and better-established companies have a higher market cap, while smaller companies have lower market caps. Large-cap shares are usually more stable, though their price rise may be slower. Smaller company shares are usually more volatile and less liquid. The vertical scale of the VRFS represents market cap, with the highest and lowest market cap on each end and the middle representing funds whose portfolios are dominated by mid-cap shares.
Apart from market cap, equity fund style also tells you whether the fund's focus is on growth or value oriented stocks or a combination of both (which we call blend). In the growth investing style, the fund manager scouts for companies with potential for faster growth than others. This optimism is reflected in the premium valuations commanded by these companies' market price. On the other hand, a value investor buys into stocks which are undervalued and have hidden potential to turn around but are usually ignored by the market.
Growth stocks typically have above average price to earnings ratio (P/E) and price to book value ratios (P/B). In contrast, value stocks have low P/Es and P/Bs. Growth stocks do well during periods of rapid economic expansion, while value stocks typically perform well during market downturns or in the initial stages of market recovery. A fund which follows growth investing will lie in the left column of the matrix and a value investing fund will appear in the right column.
The combination of these measures will represent the fund's style in terms of market cap and growth potential, through nine possible combinations. In India most multi cap funds prefer large-cap growth stocks, and so more than 75 per cent lie in this quadrant.
As with other 'statistics', there are a few caveats. As share prices change with time and so do fund portfolios, the VRFS will also change. This tool is a reflection of the overall state of the portfolio and does not signify any exclusion. Thus, a fund's portfolio may be large-cap, but this does not mean that it will not have any mid caps. The fund style just implies that a majority of the portfolio is oriented towards large caps.
The Value Research Fund Style also extends to debt funds, but that's another story.