You often hear that it is essential to diversify mutual fund investments across asset classes and categories. However, it’s equally crucial to vary investment styles within a category. You can pick a fund following growth investing style and a value style that tend to do well during different cycles of the economy.
Growth style typically does well during economic expansion, when companies reinvest earnings to spur rapid growth, as in the tech boom of the late 1990s.
Value style of investing tends to outperform during economic recoveries, when undervalued companies rebound. For example, the post-2008 financial crisis period, or more recently, the post-Covid recovery.
Where to start
The flexicap fund category is a good starting point when looking for funds with different investing approaches. With complete freedom in terms of market cap allocation and sector allocation, a fund manager in this category can fully express his or her investment style. Motilal Oswal Flexicap Fund and DSP Flexicap Fund are examples of growth-oriented flexicap funds.
Such funds typically invest in companies where earnings are expected to outperform their sector. The stocks of these companies tend to trade at higher valuations (price-to-earnings multiples) as the prices factor in a higher earnings trajectory.
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But the risk is that if the earnings growth of a company disappoints even slightly, there can be a sharp correction in its stock because the P/E multiples of such companies tend to be on the higher side due to estimates of higher earnings growth.
Franklin India Flexi Cap Fund, ICICI Prudential Flexicap Fund and Parag Parikh Flexi Cap are some examples of value-oriented flexicap funds.
The risk with value style is that there can be long periods of underperformance when the markets favour growth companies.
How to spot style
Investment styles usually depend on the fund manager or the fund house. Parag Parikh MF, as a fund house, follows a certain style. Axis MF till recently largely followed a growth approach.
At the same time, it can depend on the fund manager. Some of them have a pronounced value or growth style.
“Investors can identify the investment styles being followed in a fund by going through media interviews of the fund manager and also monitoring the fund’s portfolio to check what the fund manager is saying, [whether] he is following through with his stock selection or not,” said Deepak Chhabria, chief executive officer and director of Axiom Financial Services.
He added that investors need to be careful because fund managers can talk about growth style, but actually follow momentum style of investing. Momentum investing is simply buying stocks that have shown an upward price trend and selling those that have shown a downward trend. The idea is to capitalise on the continuing performance of existing market trends.
Mid- and small-caps
When it comes to mid- and small-caps, most fund managers look for stocks that can deliver higher earnings growth.
“In mid- and small-caps, fund managers typically look for companies that can see rapid margin and earnings expansion and hopefully transition into large-caps,” said Rushabh Desai, founder of Rupee With Rushabh Investment Services.
There are also value-oriented funds in this space including HDFC Small Cap, HSBC Small Cap Fund and SBI Small Cap Fund, which are more value-conscious when looking for investment opportunities.
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Within mid- and small-caps, you can also look at style diversification through multi-factor funds, which combine various investment strategies such as momentum and quality, where stock selection is done on the basis of these filters instead of active fund management.
Quality filtering involves the selection of stocks based on specific criteria such as strong financials, consistent earnings and low debt.
Then there are single-factor funds. You can stick with a regular diversified mid- or small-cap fund in your portfolio, with a factor-based fund in your satellite portfolio to complement it.