For Indian investors, building a diversified mutual fund portfolio often stops at spreading investments across asset classes like equity and debt, or across large, mid, and small-cap stocks. However, financial experts warn that overlooking a third critical layer—diversification across different investment philosophies—can leave portfolios vulnerable.
The Crucial Third Layer: Growth vs. Value Investing
Most discussions on diversification revolve around asset allocation and market capitalization. A frequently missed dimension is the style of investing employed by fund managers. Primarily, these styles are categorized as growth investing and value investing, each performing differently across economic cycles.
Growth investing typically shines during periods of economic expansion and high market confidence. Fund managers following this style back companies that aggressively reinvest profits to expand rapidly, aiming for earnings growth that outpaces the broader market. Investors, optimistic about future potential, often pay a premium for these stocks. The flip side is their sensitivity to sentiment; even a slight downgrade in growth expectations can trigger sharp corrections as lofty valuations unwind.
In contrast, value investing focuses on identifying businesses trading below their intrinsic value, often due to temporary setbacks. This style tends to outperform during economic recoveries following uncertainty, as these undervalued stocks rebound. Periods like the post-2008 recovery and the initial months after the COVID-19 shock saw value investing excel. However, value investors must exhibit patience, enduring long phases of underperformance until the market recognizes the stock's true worth.
How to Blend Styles in Your Portfolio
For investors seeking a blend, flexi cap funds offer a natural starting point. These funds provide managers the flexibility to invest across market caps and sectors, allowing them to express a clear investment philosophy. Some flexi cap funds lean decisively towards growth, while others tilt towards value. Holding funds with contrasting approaches can help smooth out returns across different market phases.
Identifying a fund's style requires due diligence. Deepak Chhabria, CEO and Director of Axiom Financial Services, advises investors to read fund managers' media interactions and track the portfolio to see if the stated philosophy aligns with actual stock selections. He also cautions against 'style drift,' where a growth strategy might devolve into momentum chasing.
Finding Value in Mid & Small Caps and The Rise of Factor Funds
While mid- and small-cap funds often exhibit a growth bias, seeking the next large-cap success story, value-conscious options exist. These funds adopt a contrarian or "deep value" approach, hunting for overlooked or turnaround companies trading far below intrinsic value, offering a disciplined hedge against market exuberance.
Beyond traditional active funds, factor-based investing adds another layer of style diversification. These strategies target specific, quantifiable market characteristics—or factors—like quality (profitable, low-debt firms), momentum, or low volatility. By automating stock selection based on these rules, factor funds aim to eliminate human emotional bias, providing a transparent, often lower-cost alternative that can perform even when conventional stock-picking struggles.
In essence, a truly robust portfolio is not just diversified in what it holds, but also in how it chooses those holdings. Incorporating a mix of growth, value, and factor-oriented strategies can build a more resilient investment plan capable of navigating various market environments.
