S Naren, CIO of ICICI Prudential AMC, who has been running the fund for the last 2 decades, says value investing has remained relatively uncrowded over the years.
In this exclusive chat with ETMarkets, the star fund manager talks about periods of underperformance, challenges and how his style has evolved. The IIT-IIM pass-out, who considers Warren Buffett as his guru, also shares 4 key learnings as a value investor.
Edited excerpts:
Your Value Discovery Fund has given exceptional returns at a CAGR of 21% in the last 20 years. What do you think has worked in your favour when you look back at the previous two decades, especially when so much attention was being given by others to momentum and growth?
India has been one of the best-performing markets in the last 20 years. Its strong market performance over two decades has played a significant role in our success and it has worked in our favour. Moreover, when we launched the Value Fund in 2004, value investing was relatively under-appreciated, and fortunately, it remains so even today, there weren’t and aren’t enough people who focus on value.
Because value investing hasn’t attracted the same level of interest as other strategies like momentum and growth, we’ve been able to generate long-term returns without facing overcrowding in the space. This has been a major factor in our sustained success.
If more money chases a particular stock, prices go up. How does this work in the case of value investing?
It’s true that when more money flows into a stock or sector, prices go up. But in value investing, we focus on areas where this isn’t happening—where sectors or stocks are being overlooked. It works like this: if you look back to 2020, there were sectors like telecom, metals, and PSUs, which people just did not want to touch. These sectors became extremely cheap, even though sitting at home during that COVID lockdown, people relied heavily on telecom and power to function. Despite their critical importance, these sectors were trading at the bottom (very cheap), offering good buying opportunities.
Insurance was another sector that was written off as unnecessary, leading to its significant underperformance. Some of the banks, which people had proclaimed they would never sell, were sold in billions of dollars by FIIs who no longer considered them viable investments.
When these sectors become ‘value’, that’s when we invest. Essentially, in value investing, we identify sectors where there isn’t a lot of money chasing stocks—we do things which hold value—and this allows us to buy at lower prices. The key is recognizing value where others (the market) see doubt or underperformance. That’s the essence of value investing—identifying opportunities in areas others overlook or avoid. And it works even when money is chasing other areas.
Isn’t that the biggest challenge with value investing? When a sector underperforms for a long time, how do you handle the uncertainty of whether others will discover value in it or not?
Yes, that can seem like a big challenge, but after 20 years of successfully running this fund, we’ve learned not to worry about it. If we stressed every day about it, we wouldn’t be able to stay committed to our strategy. For example, in 2020, sectors like metals and PSUs were out of favour, and this year, it is consumer companies. Yet, because we’ve consistently followed the same approach over 20 years, we’ve seen that patience pays off.
The main reason others don’t invest in these sectors is the fear of how long it will take them to recover. Why did people not buy power? Everyone knew that power was required in 2020, but they avoided investing due to concerns about how long those sectors would take to deliver returns.
We don’t let that worry affect us. So this has been a worry in people’s minds. Our experience has shown us that even during difficult periods, like 2006-08 or 2016-19 when the fund didn’t perform well, we knew things would eventually turn around. That’s the advantage of staying disciplined and trusting the value strategy over the long term.
How do the next 20 years look for value investing in India? Do you think the fund will be able to beat Nifty by as wide a margin (in the next 20 years) as it has in the past?
Value investing will do well in the long run, because at the end of the day, it’s about investing in and buying assets cheaper than their intrinsic value and waiting for that value to be realised. This principle remains strong and will work over time. Can value investing work for the next 20 years? Yes, certainly, it will. But if people come and tell you that you should expect 21%, I tell them that they need to be cautious of such advice.
Typically, we have a basket of stocks that fit the formula of value investing. Do you think five years is a good holding period for that?
Historically, there have been challenging periods, like from April 2006 to March 2009, and again from 2016 to 2019. So, while five years appears to be a good timeframe under normal conditions, it’s crucial to avoid large equity bubbles. If we experience something like Japan’s equity bubble in the late 1980s, even five years might not be sufficient for strong returns.
You mentioned your strategy has not changed in the last 20 years. How is value investing different today from what it was a decade or two back?
While the core principle of value investing remains the same, a lot has changed within the strategy. Initially, we approached value investing with a focus on low price-to-earnings and low price-to-book ratios. However, like Warren Buffett, we realised that this often led us to invest in sectors with poor long-term prospects—what we call “gruesome” sectors of the economy.
Over time, we shifted our focus toward quality sectors that were underperforming for temporary reasons, rather than those with fundamental issues. For example, we moved into sectors like telecom, metals, or power, which were facing difficulties not because they were bad businesses, but due to external factors. This was a significant shift in our approach.
Additionally, as the fund grew, we could no longer focus solely on small- and mid-cap stocks. Between 2004 and 2008, the fund resembled a small- and mid-cap fund. But now, with Rs 50,000 crore in assets under management (AUM), we’ve become more large-cap-oriented. This shift has lowered liquidity challenges from both an investor and fund manager perspective.
So, while the fundamental thought process behind value investing hasn’t changed, our strategy has had to evolve over time, and I believe it will continue to do so. For example, if the overseas investment limit is increased, we may invest more globally when India is overvalued and switch back to Indian stocks when they become more attractive. This type of flexibility will be key as the fund continues to grow.
Can you summarise the key learnings that you have had in the last 20 years? What are your biggest learnings as a value investor?
One key learning is that value investing in leveraged stocks carries significant risk and does not work. One cannot buy an NBFC or a construction company with high leverage because they can easily become bankrupt. So one basic principle we have learnt is that value investing in highly leveraged stocks is best avoided.
Second, value investing works very well in cyclical sectors like commodities. Because in commodity sectors, prices can drop suddenly and sharply—whether it’s steel, aluminum, or sugar. Value investing in some of these commodities tends to deliver strong returns if you take the right opportunity and buy at the right time during a downturn.
The third learning is when management changes in companies. If a company is underperforming and changes its leadership or management, we often find that betting on that new management pays off provided you are patient on your call. Sometimes it can even take two or three years for management change to play out. For us, it has often worked well.
Finally, sometimes, sectors just fall out of favour due to regulatory changes, and many investors give up on them. However, if that sector provides essential products or services for day-to-day living—like power, telecom or banking—they are worthwhile to invest in. Since people need their products, sooner or later, it’s likely they will recover. These are the key lessons that we have learned over the years.
