Do Value Funds Walk the Talk?

Value investing has always promised steady rewards by backing fundamentally strong companies available at attractive prices. In India, several mutual funds claim to follow this philosophy—but do they really stick to it? With changing market dynamics and performance pressures, some funds may quietly deviate from their stated strategy. In this article, we explore how such style drift affects investors and what to watch out for [EasyDNNnews:PaidContentStart]

Value investing, popularised by legends like Benjamin Graham and Warren Buffett, revolves around buying undervalued stocks trading below their intrinsic value. In India, value-oriented mutual funds promise to follow this philosophy, targeting companies that are trading at a price that is low relative to their historic performance, earnings, book value, and cash flow potential. Mostly, companies with lower price-toearnings (P/E) ratios, high dividends, and strong fundamentals that are overlooked by the market fall into this category. This is an ideal situation that a fund should follow. However, not all funds stick to their stated strategy. A phenomenon called style drift—where fund managers deviate from their declared investment style—can silently alter a fund’s risk-return profile, leaving investors exposed to unintended risks. In this article, we will explore how Indian investors can identify style drift in value funds, evaluate its implications, and safeguard their portfolios. We decode why style drift happens, how to spot it, and whether it aligns with your financial goals. 

What Is Style Drift? Style drift occurs when a mutual fund’s actual portfolio holdings diverge from its stated investment objective. For example, a value fund might start buying high-growth tech stocks with inflated valuations, and a Large-Cap fund could increase exposure to Mid-Cap stocks for higher returns beyond those prescribed by SEBI. In India, SEBI’s 2018 categorisation norms mandate strict allocation rules (e.g., large-cap funds must invest 80 per cent of assets in the top 100 companies by market cap). However, the remaining 20 per cent allows flexibility, which some managers exploit to chase short-term trends. 

Types of Style Drift:
1. Passive Drift: Occurs due to market movements (e.g., a mid-cap stock held by a fund grows into a large-cap).
2. Active Drift: Deliberate shifts by fund managers to capitalise on trending sectors or styles, often to attract inflows or boost returns. 

Why Do Fund Managers Drift? Lessons from Global Markets
Research from various markets has found that fund managers may deviate from their declared investment style for various reasons, often driven by incentives and performance pressures. One key motivation is the link between compensation and assets under management (AUM). Managers may alter their strategy to temporarily enhance returns and attract more investor inflows, even if it means straying from their core investment mandate. For instance, a fund focused on value investing might shift towards high-momentum stocks during favourable market conditions to demonstrate short-term gains. Additionally, underperformance relative to peers can push managers to abandon their original strategy in an attempt to close the gap, although such reactive moves seldom lead to sustained improvement. Research also suggests that while moderate, longer-term style shifts by experienced managers can sometimes add value, short-term deviations tend to be speculative and often undermine long-term performance. These findings clearly show the complex trade-offs managers face between staying disciplined and responding to market dynamics or investor expectations. 

How Style Drift Impacts Investors
1. Altered Risk Exposure ― A value fund drifting into growth stocks exposes conservative investors to higher volatility. For instance, during the 2021–2022 tech rally, some Indian value funds loaded up on overvalued IT stocks, only to suffer when the sector corrected.
2. Misalignment with Goals ― Investors choose value funds for stability and downside protection. Drift into a speculative style disrupts this balance, potentially derailing long-term goals like retirement planning.
3. Hidden Costs ― Frequent portfolio churn to accommodate drift increases transaction costs and tax liabilities, eating into returns. 

Detecting Style Drift: A Step-by-Step Guide for Investors 

1. Scrutinise Portfolio Holdings

• Check Factsheets Monthly: Fund houses give disclosure of top holdings and sector allocations every month. Look for:
• Rising exposure to high-P/E stocks (e.g., a value fund holding Nykaa or Zomato during their IPO peaks).
• Sector concentrations outside traditional value sectors into growth sectors should alarm.
• Compare with Benchmarks: A value fund should closely track indices like Nifty 500 Value 50. Significant deviations from these indices show a style drift. 
   

2. Analyse Performance Correlations

• Download historical NAVs of the fund and Value equity index and calculate their rolling correlation. If your value fund’s returns are poorly correlating with the Value index, it’s likely that your fund is drifting.
  
  3. Track Manager Commentary
   
• Listen to the fund manager’s address to unitholders or read quarterly letters. Managers justifying shifts like, ‘We added tech stocks for diversification,’ may indicate active drift.
  
  4. Use Quantitative Metrics
   
• P/E and P/B Ratios ― Compare the fund’s weighted average P/E or P/B with its benchmark. A value fund’s P/E should ideally be lower than the broader market.
• Turnover Ratio ― High turnover (e.g., >50%) suggests frequent trading, often linked to drift as value investing mostly means buy and hold. 

Style Drift of Indian Value Mutual Funds
To understand the style drift of Indian mutual funds under the value category, we did research where we covered most of the funds in the value category. This research aimed to evaluate the style consistency of value mutual funds by comparing their performance and behaviour over time with the Nifty Value index, which serves as the benchmark for value investing. By analysing historical NAV data, we tried to understand whether these funds have remained true to their value investing mandate or have drifted in style—a phenomenon that we discussed above as style drift. We analysed it through the use of rolling 52-week correlation, beta, and R-squared metrics. This helped us to quantify how closely each fund’s returns align with the benchmark, thereby revealing shifts in investment style. Additionally, we also examined the rolling Sharpe ratios and volatility of weekly returns to assess risk-adjusted performance and consistency. This comprehensive approach helps identify which funds have remained faithful to value investing, which have deviated, and which ones offer more stable, efficient returns over time. 

Relative Return of the Funds and Nifty Value Index 

Following are the results of the above research: R-Squared (Explained Variance)
The R-squared values show how much of the fund's movement can be explained by its relationship with the Nifty Value index. Higher R-squared values (close to 1) indicate that the fund's performance is strongly aligned with the benchmark, meaning it adheres closely to the value strategy. Conversely, lower R-squared values suggest that the fund's performance is diverging from the benchmark, which could imply a shift in style. If we observe a declining trend in R-squared over time, it would suggest that the fund may be exhibiting style drift, moving away from its original value investing mandate. The analysis of the R-squared values reveals key insights into how well various funds adhere to their value investing mandate. Funds such as ICICI Prudential Value Discovery Fund, HSBC Value Fund, and Templeton India Value Fund demonstrate consistently high R-squared values (around 0.8 or above), indicating a strong alignment with the Nifty Value Index and suggesting that these funds remain true to their value investing strategy. On the other hand, funds like Quantum Value Fund exhibit occasional dips below 0.6, reflecting volatility and partial deviation, possibly adopting a more blended or aggressive approach at times. Similarly, the Nippon India Value Fund, which was once closely aligned with the benchmark, has shown increased fluctuations post-2020, hinting at a potential shift in investment style. JM Value Fund also demonstrates a wide range of R-squared values, indicating inconsistent tracking of the benchmark, and may not strictly adhere to the value investing approach. Furthermore, the Bandhan Sterling Value Fund stands out with some of the lowest and most volatile R-squared values, frequently dropping below 0.6, which points to a significant divergence from its value investing mandate. In essence, declining R-squared values or values consistently below 0.6 strongly suggest that a fund is no longer following a traditional value strategy, while consistently high R-squared values (~0.8– 0.9) indicate disciplined adherence to the value investment theme. 

Correlation (Fund vs. Benchmark)
The correlation measures how closely the fund's returns move with the Nifty Value Index. A high positive correlation (close to 1) indicates that the fund is behaving similarly to the index, reflecting consistency in its value investing approach. A declining correlation over time would suggest that the fund is decoupling from the benchmark, possibly indicating that the fund's strategy is evolving away from value investing. Significant fluctuations in correlation may also hint at occasional changes in the fund's positioning or management decisions. 

The correlation with Nifty Value Index highlights the degree to which each fund is aligned with the benchmark. Most of the funds maintain a strong correlation, with values consistently above 0.8, especially for BANDHAN Sterling Value Fund and Templeton India Value Fund, indicating that their movements are largely driven by the performance of the Nifty Value Index. However, HSBC Value Fund shows more fluctuating correlations, particularly in the last decade, suggesting that their performance is drifting away from the benchmark and possibly straying from their intended value investing strategy. 

Beta (Market Sensitivity)
Beta measures the sensitivity of a fund's returns to movements in the benchmark index. A beta of 1 means the fund moves in line with the index, while a beta greater than 1 indicates that the fund is more volatile than the index, and less than 1 indicates lower volatility. A rising beta over time may suggest that the fund is becoming more aggressive and possibly taking on more risk, while a decreasing beta might indicate a shift towards a more conservative strategy. If the beta diverges significantly from 1, it could signal that the fund is moving away from its original value investing focus. 

The beta values provide an additional layer of understanding of style drift. Funds like JM Value Fund and Nippon India Value Fund show higher beta values, indicating that they are more volatile and sensitive to market swings compared to the benchmark. This could imply a shift towards a more aggressive approach than what is typically expected from a value investing strategy. In contrast, Templeton India Value Fund and ICICI Prudential Value Discovery Fund demonstrate lower beta values, reflecting a more stable and less volatile exposure to the market, which is more in line with a traditional value investing approach. 

Sharpe Ratio (Risk-adjusted Return)
The Sharpe Ratio measures the risk-adjusted return of each fund. A higher Sharpe ratio indicates that the fund has delivered better returns relative to the risk taken. By analysing the rolling Sharpe ratio, we can identify whether the funds are consistently generating high returns for the level of risk they assume. A decline in Sharpe ratio over time might signal that the fund is becoming more risky or less efficient in generating returns, which could also be a sign of style drift—moving from a stable, conservative approach to a more volatile strategy. 

The Sharpe Ratio shows a mixed trend across the funds. While many of the funds, such as HSBC Value Fund and ICICI Prudential Value Discovery Fund, exhibit consistent Sharpe ratios above 0.2, a few, like JM Value Fund, show significant fluctuations, particularly during market volatility periods. This suggests that while some funds have managed to sustain positive risk-adjusted returns, others have struggled with either excessive risk or subpar returns during certain market phases. 

In conclusion, while most of these funds align relatively well with the Nifty Value Index, a few have shown signs of style drift through lower R-squared values, higher betas, and fluctuating correlations. This could indicate a shift towards growth or momentum strategies, veering away from their original value-focused mandates. Investors should pay close attention to these trends to ensure their funds continue to adhere to the value philosophy. 

By evaluating these four statistics, you can track each fund's adherence to its value strategy over time and determine if there is any style drift occurring. If multiple funds show consistent declines in R-squared, Sharpe ratio, or correlation, along with rising beta, this could indicate that the funds are gradually deviating from their intended value style. 

SEBI’s Role and Limitations
SEBI’s categorisation norms prevent extreme drift (e.g., a large-cap fund cannot become a mid-cap fund). However, the 20 Per cent “flexibility” loophole allows tactical shifts. Investors must self-monitor, as regulators don’t penalise minor deviations. 

Should You Tolerate Style Drift?
Not all drift is harmful. Skilled managers may temporarily pivot to capitalise on opportunities (e.g., buying beaten-down pharma stocks during COVID). However, consistent, unexplained deviations are red flags. 

Ask These Questions:

• Is the drift intentional or due to passive market movements?
• Does the manager have a proven track record of style timing?
• Are higher returns sustainable, or a short-term gamble? 

Protecting Your Portfolio: Actionable Steps
1. Regular Reviews ― Compare your fund’s holdings and performance with its mandate every quarter.
2. Diversify Across Styles ― Pair value funds with low-correlation assets (e.g., index funds) to mitigate drift risks.
3. Opt for Consistent Performers ― Choose funds with a history of style adherence (e.g., HDFC Capital Builder Value Fund). 4. Exit Strategically ― If drift persists, switch to passively managed value ETFs (e.g., Nippon India Value Fund) with stricter mandates. 

Conclusion: Empowerment Through Vigilance
Style drift is a double-edged sword. While it can reflect managerial agility, unchecked deviations risk compromising your financial goals. Indian investors must stay vigilant, leveraging SEBI disclosures and global insights to hold funds accountable. By prioritising transparency and consistency, you can ensure your value funds remain true to their mission— delivering steady, risk-aware returns in line with your aspirations. 

In the words of Warren Buffett, ‘Risk comes from not knowing what you’re doing.’ With the right tools and awareness, you can master the art of knowing exactly where your money is working—and why.

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