The pitched battle between index funds and exchange-traded funds versus actively-managed peers continues, with many in the latter club, despite notching up stellar returns needing to generate alpha. Sample this: Value investing funds have clocked a decent 27.4 per cent CAGR in 3 years, but every second scheme has under-performed respective benchmarks. So, many actively-managed value funds need help to match their benchmarks. In this backdrop, UTI Mutual Fund has thrown its hat into the passively-managed value funds arena, with the launch of UTI Nifty 500 Value 50 Index Fund (NFO closes May 8, 2023). Active fund or passive? Which style makes for a better fund in the value category? Let us look at what are the existing options available to fund investors and how they have performed.

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Value investing basics

Value investing is a strategy that involves picking securities that appear to be trading for less than their intrinsic value. Fund managers buy undervalued stocks believing they will eventually increase in price as the market recognises their true worth. The advantages of value investing are the potential for high returns, less volatility and portfolio diversification. On the flip side, the value investing approach involves a lot of patience, the possibility of buying value traps, limited upside potential compared to growth stocks, and research-intensive exercise. Here is how, as a category, active-managed value funds have done against their benchmarks

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ETF options

At this moment, 5 ETFs have a value investing approach. They are Motilal S&P BSE Enhanced Value ETF, HDFC Nifty50 Value 20 ETF, Kotak Nifty50 Value 20 ETF, IPru Nifty50 Value 20 ETF and Nippon India Nifty50 Value 20 ETF. From a total expense ratio perspective, they cost 0.14-0.50 per cent compared to 1.3-2.5 per cent for actively-managed value funds.

Let us look at the underlying indices before going into the ETFs. As you can see, these ETFs track two indices - S&P BSE Enhanced Value Index and Nifty50 Value 20 Index.

The S&P BSE Enhanced Value Index is designed to measure the performance of the 30 companies in the S&P BSE LargeMidCap with the highest valuations based on three fundamental measures – book value-to-price, earnings-to-price and sales-to-price. So, the stock universe is large and midcap. The basket’s current top holdings are concentrated in metals/mining, energy and PSU banks such as Hindalco, Tata Steel, ONGC, Vedanta, NTPC, Coal India, Bank of Baroda, IOCL, Gail India and Canara Bank.

In comparison, the Nifty50 Value 20 Index is designed to reflect the behaviour and performance of a diversified portfolio of value companies forming a part of the Nifty 50 Index. So, the stock universe is essentially giant caps. The current top holdings of this basket are much more diversified in terms of sectoral exposure (FMCG, IT, Mining and Power). This list includes ITC, TCS, Infosys, HUL, HCL Technologies, Tata Steel, NTPC, Power Grid, JSW Steel and Tech Mahindra.

Motilal S&P BSE Enhanced Value ETF is less than one year, so does no longer has a performance history. In the six months, the ETF gained 16 per cent, widely outperforming BSE 100, which has been flat. This is also a period when value stocks generally, have done better. Similarly, HDFC Nifty50 Value 20 ETF is also less than one year old. In the six months, it has clocked a 3.4 per cent return, which is better than broader markets. The balance 3 ETFs i.e. Kotak Nifty50 Value 20 ETF, IPru Nifty50 Value 20 ETF and Nippon India Nifty50 Value 20 ETF, have a 6-7 year NAV history, which lends them to longer-term return analysis. The one-year and three-year monthly tracking error of all these 3 ETFs is similar (1yr: 0.03 and 3yr: 0.05-0.06). To check returns vs the value funds category as well as the Nifty 500 Value 50 index based on which the UTI NFO has come up, look at the table below.

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Index fund options

Including the newly-launched UTI Nifty 500 Value 50 Index Fund, there are three index funds in the value funds arena. The other two products are Nippon India Nifty50 Value 20 Index Fund and Motilal S&P BSE Enhanced Value Index Fund. Index funds allow investors to make SIP investments and you don’t require a mandatory demat account to operate it (unlike ETFs). However, index funds are a bit more costlier than ETFs, i.e. 0.8-1.01 per cent (TER).

UTI Nifty 500 Value 50 Index Fund will track the Nifty 500 Value 50 Index Fund, which is unique in certain ways. The Nifty 500 Value 50 index consists of 50 companies from its parent NIFTY 500 index, selected based on their ‘value’ scores. The value score for each company is determined based on the Earnings to Price ratio (E/P), Book Value to Price ratio (B/P), Sales to Price ratio (S/P) and Dividend Yield. The Nifty 500 is a multi-cap index, which, at least on paper, opens up the index basket to large-, mid- and small-cap stock exposure compared to the existing value-oriented passive fund options, both ETF and index funds, which are biased towards large-caps. However, the existing top-10 holdings of this index are Power Grid, NTPC, BPCL, ONGC, PFC, Tata Steel, Grasim, IOCL, Vedanta and Hindalco. Once you go past the top-10, you can see names such as Exide, Petronet, LIC Housing, CESC, NCC, and Great Eastern Shipping.

In terms of index tracking returns, the two existing value-oriented index fund options show divergent trends. Motilal S&P BSE Enhanced Value Index Fund has a much higher tracking error (1-yr monthly: 0.79), while Nippon India Nifty50 Value 20 Index Fund (1-yr: 0.03 and 3-yr: 0.12) is more reasonable. Regarding performance, both index funds have short track records, so return data may not be used to conclude anything material. The 1-yr return of Nippon India Nifty50 Value 20 Index Fund is about 2 per cent, underperforming the value funds category and broader markets. Motilal S&P BSE Enhanced Value Index Fund doesn’t even have one-year NAV history, but in the six months has clocked nearly 15 per cent returns, better than the category and overall market.

While the Nifty 500 Value 50 index per se seems to have clocked higher returns than other value indices, the BSE 100 and the category average of value funds over 1 and 3-year periods, have lagged them over a longer period of 5 years. One needs to wait and watch the performance of the new UTI Nifty 500 Value 50 Index Fund.