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Suresh Krishnamurthy

THE striking feature of stock market performance in 2003 and 2004 has been the strong returns generated by the `value investing' strategy. The performance of value funds was so impressive that a host of value investment philosophy funds, especially dividend yield funds, was launched.

A plethora of mid-cap funds, too, was launched during the same period as superior performance of `value investing' also means superior performance of mid-cap stocks.

With the burgeoning number of such value and mid-cap funds now open for investment, the focus has shifted to the issue of whether the existing benchmarks will be useful in analysing the schemes' performance.

If past performance is any indicator, existing benchmarks are certainly enough. Intuitively, however, the answer is `no' as the characteristics of the Indian stock market appear to have changed significantly.

The time has truly arrived to establish benchmarks that will better serve the purpose of evaluating the fund managers of value and mid-cap funds. These funds manage more than a few billion dollars between them. AMFI and SEBI, which did a good job in creating benchmarks for the debt and balanced schemes, need to get their act together again.

Returns to value: Value investing as a strategy seeks to invest in stocks that are trading below their intrinsic value.

Investment strategy based on low price earnings ratio (Tata Equity P/E) and high dividend yields (Birla Dividend Yield Plus) are examples of value style investing.

Funds such as UTI Master Value, Templeton India Growth, Birla Dividend Yield Plus and SBI Magnum Contra, which stuffed their portfolio with value stocks, reported strong performance in 2003 and 2004. So did mid-cap schemes such as Franklin India Prima, Reliance Vision and SBI Magnum Global.

These schemes beat indices such as BSE 200 and S&P CNX 500 handsomely. Most of the mid-cap schemes also under-performed CNX Mid-Cap 200.

In this context, would a comparison with these indices be sufficient to analyse the performance of the manager? As far as the past few years are concerned, these indices would have served the purpose to a large extent. This is because of the correlation in returns of these schemes with those of the indices.

For instance, 85 per cent of the monthly returns of UTI Master Value were explained by changes in CNX Mid-Cap 200 between 2001 and 2004. Similarly, close to 90 per cent of the monthly returns of Templeton India Growth were explained by changes in BSE 200 between 2001 and 2004.

Divergent trends: The future, however, could be substantially different. The re-rating of stocks, belonging to genres such as growth and value, large-cap and mid-cap is now almost over. The valuation of a greater number of stocks now factor in sizeable earnings growth over the next three years.

The size of the market at about Rs 17 lakh crore is also several times more than what it was a couple of years ago. A number of mid-cap stocks are now trading at price to earnings multiple that is higher than that of their larger counterparts. A number of large-cap and mid-cap stocks also appear set to get listed over the next few years.

These factors suggest that the future, in terms of trends, could be vastly different from that of the past. Divergent trends in returns and volatility of growth and value stocks as well as large-cap and mid-cap stocks seem set to emerge.

In this context, existing indices may fail to satisfactorily answer questions relating to fund manager performance in future.

Fund managers of a few value and mid-cap schemes have also indicated that the existing indices are not appropriate as benchmarks.

Fund managers also indicate that even CNX Mid-Cap 200 is not an appropriate index for mid-cap stocks since it includes a mix of both mid-cap and small-cap stocks.

According to them a blend of Nifty Junior and CNX Mid-Cap 200 would be more appropriate.

Thus the case for appropriately defined benchmarks for value and mid-cap investing has never been stronger.

The fund managers are, however, unlikely to find a solution to this issue, even if they can. The initiative has to come from AMFI or SEBI.

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