Why Tata Equity P/E Fund is a good pick

Amid the stock market’s continued upward march and stretched equity valuations, there is renewed interest in value stocks. Right on cue, many mutual fund AMCs have rolled out value funds in recent months.

Funds that follow a ‘value’ strategy invest in stocks that are trading below their intrinsic value (based on company fundamentals) and offer scope for price appreciation over time. The reasonable stock valuations offer investors a margin of safety.

Those wary of expensive equity valuations can consider investing in a value fund. Tata Equity P/E Fund is among the top performers in this category. It has provided good downside protection too.

Investors should note that value funds may go through long periods of underperformance, as they did in 2018 and 2019, before delivering. Over the past year, value funds have generated returns of 52 to 94 per cent. Therefore, having an investment horizon of five years or longer and diversifying across funds following value and growth strategy helps.

Strategy and performance

By mandate, Tata Equity P/E Fund must invest at least 70 per cent of its net assets in stocks with a 12-month trailing price-to-earnings or P/E ratio lower than that of the S&P BSE Sensex. That is, valuations relative to that of the Sensex are used as a criterion for filtering stocks, which are further screened based on their growth potential. Selection is based on factors such as market leadership, sector opportunity, consistency of return ratios such as the ROE, and stock liquidity. The scheme invests in companies across sectors and of different market cap — large, mid and small-cap.

Tata Equity P/E Fund has been among the top performers in the category based on 3-year and 5-year rolling returns (CAGR) over the last seven years. During this period, the scheme generated an average 3-year return of 11.3 per cent compared to 8.7 per cent for the category and an average 5-year return of 11.8 per cent versus 9 per cent for the category. Schemes with a history of less than seven years and assets under management below ₹300 crore have been excluded here.

Based on past seven years’ data, Tata Equity P/E Fund has displayed good downside protection. A downside capture ratio or DCR of 84 per cent (value less than 100 per cent) with respect to the Sensex TRI implies that the scheme captured less of the market downside in years when the broader markets fell. This is at the lower end of the DCR range of 75 to 108 per cent for value funds.

During this period, the 3-year rolling returns for the scheme were negative only 6.5 per cent of the time compared to 15 per cent for the category. If we go by 5-year returns, the scheme had no instances of negative returns. In fact, 90 per cent of the time, the 5-year scheme returns were at least 6 per cent (CAGR) or higher. This was true for the category only 76 per cent of the time.

Portfolio composition

Tata Equity P/E Fund invests 55-75 per cent of its corpus in large-cap stocks, another 15-25 per cent in mid-caps and 5-15 per cent in small-caps. The scheme is diversified across sectors too.

After the market high in August 2018, the scheme cut its exposure to large-caps from 74 per cent to 56 per cent by October-end. During the same time, it raised the cash and cash equivalent holdings from 5 per cent to 25 per cent. The mid-cap exposure was pared to 12 per cent. As the markets started picking up from November 2018, large-cap and mid-cap allocations were upped to 70 per cent and 23 per cent respectively by November 2019. With the large cap-driven market rally continuing in 2021, the scheme has pared its large and small-cap holdings while keeping that in mid-caps unchanged as they still present some opportunity.

Sector-wise, banking, software, finance and consumer goods accounted for the top holdings in August-end 2021. The top stocks — ICICI Bank, HDFC Bank, Reliance Industries, HDFC, ITC, HCL Technologies and Infosys — had a 42 per cent share in the portfolio. The sector holdings have undergone a change since the March 2020 low. The largest hike - 14 percentage points - has been for software. On the other hand, the share of finance, petroleum products and auto and auto ancillary stocks has been pared.

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