ICICI PRU DISCOVERY FUND A PRIMER

With broader market valuations moving into expensive zone, a focus on ‘value’ stocks may be a good strategy to follow now. ICICI Pru Discovery is one of the rare equity funds in India that practises value investing (most equity funds here have a ‘growth’ bias) and what is more, with a tilt towards mid- and small-cap stocks.

As this structure makes for a portfolio that is very different from most other equity funds, ICICI Pru Discovery is a good investment option for investors with some appetite for risk. The average PE multiple of the fund’s portfolio stood at a modest 13 times by end of August — a steep discount to market valuation of over 20 times.

Suitability: ICICI Pru Discovery appears to be a lower risk option within the universe of mid-cap funds. ICICI Pru Discovery has invested well over two-thirds of its portfolio in mid and small cap stocks (market cap less than Rs.7500 crore) this year.

That does peg up the risk profile of the fund in relation to large-cap focussed funds or index funds. However, the fund has managed to keep its Beta (tendency to move with the Sensex) low through unconventional stock choices. Contrarian stocks and sectors picks dominate its portfolio and a focus on low PE stocks protects value.

Performance: The ICICI Pru Discovery has managed to comfortably outperform peers and its benchmark over five-year and one-year time-frames, but has lagged over a three year period. The returns stand at 28 per cent compounded annual return over five years, falling to about 10 per cent over three years, followed by a robust 36 per cent for one year.

The fund’s five-year record puts it among the top performing equity funds. What is noteworthy is the fund’s reasonable success in containing downside during the corrective phase last year. Between January 2008 and March 2009, the Discovery Fund managed to contain the fall in its NAV to about 59 per cent, marginally less than the Sensex. Given that even large-cap funds struggled to do this, this is a good showing from this mid-cap oriented fund.

The explanation for this performance probably lies in the fund’s strict adherence to the “value investing” mandate. Mid-cap stocks from sectors such as banks, pharmaceuticals, auto components and FMCGs dominated the portfolio in March, keeping the portfolio PE at a modest 7.7 during the market lows.

With market valuations rising, the portfolio too has become more expensive. By end of November, the top sector choices were again pharmaceuticals, banks, and software companies.

But with the fund taking care to hold a good number of low PE stocks (Cadila and FDC in pharma, ING Vysya and Corporation Bank in financials and so on), average valuations for the portfolio, at 13, have in fact widened their discount to the Sensex (20) and the Midcap Index (about 17).

This may not help the fund entirely avoid a fall in its NAV, should the broader market correct; but it may certainly help contain it.