by Nityanand Prabhu, Executive Director and Business Leader, LIC Mutual Fund
May 2022 was an eventful month as the Reserve Bank of India (RBI) surprisingly increased the benchmark repo rate by 40 basis points. Financial markets were quick to react to the RBI’s action. The benchmark 10-year bond yield of 6.54% to 2032 rose 26 basis points to 7.3783% on the day of the rate hike. The stock market, still reeling from the rate hike, was shaken again when data showed consumer price inflation accelerating at the fastest rate since 2014. retail jumped to 7.79% in April, which weakened financial markets. On May 13, the Nifty 50 fell to 15,782, 13% lower than its April 4 close.
We believe that we have entered a regime of increasing inflation which requires a readjustment of the objective to review their approach and their investment strategy. Inflation should keep equity markets nervous in the near term. Investors with a relatively high appetite for risk can turn to equity mutual funds.
Typically, stock market investments seek value or growth. In value investing, fund companies invest in companies that are industry leaders and have inherited a core business with established dominance in the industry through performance, high brand value and strong customer loyalty. These companies are showing a moderate but sustained rate of growth. Value companies have established a strong foundation in their operating chain with strong balance sheets and reserves.
Growth companies are typically emerging companies that focus on innovations and thrive on unique selling proposition (USP) and competitive advantage. Their uniqueness lies in advanced technology, product differentiation, distribution configuration, dynamic pricing, among others. They are sometimes the disruptors because they have a less profitable business model. They pay very little or no dividends due to a reinvestment protocol. They focus on brand loyalty or product acceptance.
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From an investment perspective, the above two types of businesses have proven to be long-term wealth-generating investments. However, in the current situation of rising inflation, value stocks seem better positioned than growth stocks.
Inflation in general has a negative impact on profitability. For consumers, this impacts their affordability as purchasing power per unit of consumption declines. Rising input costs put pressure on business margins, which impacts profitability, making it a vicious circle. This is precisely why growth stocks experience a correction in valuations during this period. Unlike value stocks, the valuation of growth stocks is a function of income growth, and as consumer affordability declines, income growth slows. The data suggests that the inflationary environment bodes well for value stocks. Valuable companies find it easy to accept price increases without much impact on incremental sales due to brand awareness and consumer acceptance. Customers tend to stick with the brand despite rising prices, due to the quality and connection to the brand.
This is already visible in the earnings result of companies. Fast-moving consumer goods companies raised prices for soaps and detergents, coffee and cookies in the fourth quarter of fiscal 2022 as commodity prices soared. The moot point here is that high inflation is transitory in nature and can slow down in a few years, but companies don’t undo price increases when inflation goes down. Over the years, value company margins have increased significantly for the same set of companies mentioned above. Clearly, value companies make a good case for investing in the rising inflationary regime.
This is not only reflected in profitability but also in share prices. Data from Bloomberg indicates that the quarterly outperformance of outgrowth value stocks was the strongest in the past year. This is precisely why these companies manage not only to stay in business when inflation picks up, but also enjoy high margins and profitability when the pace of price increases slows. These companies are also gaining market share through growth stocks and unorganized players in a rising inflationary regime. The practice of identifying and investing in companies of value is woven into LICMF’s investment philosophy.
At LICMF, our flagship funds such as the LICMF Large Cap Fund and the LICMF Large & Midcap Fund follow a rigorous process of selection, review and monitoring when it comes to value investing. The philosophy involves investing primarily in companies with strong leadership, operating heritage, strong brand loyalty, competent corporate governance and a sustainable business growth model. Investors can consider investing in our flagship funds through a lump sum or SIP. However, we recommend that investors take the help of financial advisors after a thorough discussion of risk appetite, return expectations and investment horizon in order to make an informed decision.
Disclaimer: This disclaimer informs readers that the views, thoughts, and opinions expressed in the article belong solely to the author, and not necessarily the employer, organization, committee or to any other group or individual of the author. INVESTMENTS IN MUTUAL FUNDS ARE SUBJECT TO MARKET RISK, READ ALL PLAN MATERIALS CAREFULLY.