Does value investing make sense amid rising interest rates?

When interest rates start to rise, value becomes a better investment strategy as the downside in value is limited versus the downside in growth.

This, in a nutshell, is value investing—where investors give preference to firms that have low valuations compared to their intrinsic value, have decent cash flows in their businesses and, in some cases, have a high dividend yield attached.

With interest rates now rising globally, as central banks focus on taming high inflation, some experts say it is time for value investing again.

“High inflation means high cost of capital. The latter implies that companies which derive value from near-term cash flows are lesser impacted from any increase in discount rate than those that derive value from long-term cash flows,” said Meenakshi Dawar, fund manager, Nippon Life India Asset Management Ltd.

Dawar is of the opinion that there is a strong case for value investing now, as earnings over the last two-three years have become broad based.

“The high growth premium that few companies have been getting should narrow from here. Further, high inflation and high cost of capital favors value companies,” the expert said.

The high inflation period can be beneficial for specific sectors and stocks. According to experts, inflation leads to an increase in costs of raw material, among others.

“Businesses that are able to pass on the impact of this rise in prices to their consumers will do better. Same is the case with businesses having access to low cost capital than those that borrow money at a higher cost,” said Mayukh Datta, head, product-strategy and communication, Mirae Asset Investment Managers (India) Pvt. Ltd.

“For example, banks which do not raise term deposit rates in line with their loan rates can do well as their margins go up. Energy firms can do well as customers need energy products for their own consumption or for running their factories and plants even if energy costs go up. Agri products can benefit as companies pass on the costs to their customers,” Datta said.

Meanwhile, Dawar believes that companies that are producers will do better than ones that are consumers. “For example, sectors such as metals, agri producers, energy, building materials, chemicals, etc., will have a direct earning correlation to higher inflation,” Dawar said.

Further, if the inflation is because of better demand recovery, there is broad basing of market returns, meaning sectors such as industrials, infrastructure, real estate, etc., tend to do better.

On a year-to-date basis, Sensex and Nifty are 10% in the red, while S&P 500, which is a broad index representing 500 US-listed companies is down around 19% over the same period.

Overall, valuations have come down across many businesses. While equity markets have become cheaper, experts say one cannot depend only on value investing.

Investors need to check the reasons for the fall of business valuations and then make an informed decision, they add.

On the debate of growth vs value, Kirtan Shah, founder and CEO, Credence Wealth Advisors, said, “Investors should always stick to their asset allocation, as nine out of 10 people might not be able to time the market. However, for people who understand markets, value might make a lot of sense today. Ideally, as a retail investor, you should have both, value and growth, in your portfolio.”

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