Value funds are mutual funds that follow a value investment strategy. The fund managers of these funds invest in undervalued stocks that trade below their respective intrinsic value. The stock price of many companies in the market is not an accurate indicator of their actual valuation.
They have the potential to grow, and their intrinsic value is more valuable. The fundamental analysis of the company determines the intrinsic value of a stock. Some of the fundamental factors are business financials, competitive position, financial ratios like PE ratio, PB ratio, ROE, etc.
The portfolio of value mutual funds invests across different sectors and market capitalisation. There are several fundamental metrics that the fund manager uses to identify the value stocks. Besides this, these stocks have a lower downside. In other words, the probability of undervalued stocks is that they fall further is significantly less. Therefore, the risk associated with value funds is that they can be consistent under performers even during a bull market phase. These funds tend to reward those with long holding horizons.
Diversification : Diversification is a crucial advantage of investing in value funds. It invest across sectors and market capitalisation. This ensures that a part of the portfolio can do well at all times.
Downside Protection: The downside fall of value stocks can be lower than the overall market because it focuses on cheaper stocks and is less vulnerable to market movements. Thus, these funds invest in stocks that do not have high expectations in the short term. Also, it protects from adverse market conditions.
Established Investment Strategy: This is one of the investment strategies across mutual funds which has been successful globally. Picking up stocks at their intrinsic value that have the potential to grow helps in generating growth across market cycles.
Investing by Facts: Fund managers select value stocks after doing an in-depth fundamental analysis of the company. Also, the value investing strategy follows a comprehensive study of the company and its future prospects. Therefore, fund managers invest based on solid research and facts rather than speculating.
Risk : There is a risk associated while investing in undervalued stocks. Any miscalculation by the fund manager in picking up stock may result in losses. Thus, this might reflect in the NAV of the fund.
Underperformance: Sometimes the value stocks do not perform as per the expectations. Therefore, in the bull markets where investors pay a premium for future growth, the value funds may underperform as the fund managers do not invest in high growth or high valuation stocks.
Holding Period: For the value investing strategy, stock price discovery may take a longer time than anticipated. The fund manager picks low price stocks, which may turn around in several years. At the same time, some stocks can be multi-baggers in a short period.
Who Should Invest in a Value Fund?
Most investors prefer funds that combine growth and value investing strategies to generate wealth in the long term. However, it takes much time, effort and market awareness to find the right stock and purchase them at the right time. Therefore, value mutual funds are suitable for investors who find the process of selecting value stocks overwhelming.
Value stocks are expected to perform better in the long term due to their strong intrinsic value and company fundamentals. Over a period of time, the stock value can increase or decrease. Therefore, investors with a long term investment horizon can prefer investing in value funds. Moreover, investors with high exposure to growth stocks can opt for value funds to give stable returns in any market cycle.
Things to Consider
Past Fund Performance: Looking at the past performance over a 5-7 years period is critical in a value fund. This helps to analyse how the fund manager has managed to achieve the fund’s investment objective across the market cycle while following the value investing strategy. Therefore, investors must look at the selection of stocks in the fund’s portfolio and the overall past performance of the fund to make an informed decision.
Investment Horizon: These funds are suitable for investors with a long term investment horizon. Hence, an investor must stick to their investment horizon, which will help them obtain significant returns. Also, in value investing, fund managers pick low-cost stocks which might take time to perform. Therefore, it is recommended that investors with a minimum of 5 years investment horizon can invest in value funds.
Investment Objective of the Investor: These funds have an investment strategy that can benefit investors to achieve their long term objectives. For example, child’s education, children’s marriage, retirement planning, etc. Hence, selecting a diversified value fund across market capitalization helps create growth in the long run. Also, it is advisable to attach a financial objective to their investment.
Expense ratio: Like other mutual fund categories, these funds also charge a fee for managing investors’ money. The fee charged is called an expense ratio. If the fund manager often changes the portfolio, it might result in higher transaction costs, resulting in a higher turnover ratio. Therefore, investors must look at this factor before choosing this fund as it might impact the fund performance.
Fund Objective: The value investing strategy aims to create wealth in the long term by investing in stock at its intrinsic value. Also, the fund managers may invest in large-cap companies or small/mid-cap companies. Hence, investors must consider diversification while selecting funds, as putting all eggs in one basket is not an intelligent investment strategy. Also, the investor’s investment objective should be in line with the fund objective to help them achieve their financial goals in the long run.
Risk: Mutual funds investments are market-linked. These funds also face risks depending on the market conditions. Hence, a fund manager plays a vital role in managing the asset allocation to take advantage of a dynamic market. Therefore, these funds can have lesser risk than a pure mid-cap or small-cap fund.
Besides the above parameters, investors should also consider the Sharpe ratio, Treynor’s ratio, standard deviation, alpha and beta. Some investors lack time to do their research. Thus, they can always consult a financial advisor to guide them in their investments.
To sum up, value mutual funds can be a good addition to an investment portfolio. The principle of value investing has led Warren Buffet to become a successful investor. It is all about picking a trustable company, knowing its intrinsic value and being an intelligent investor to create wealth in future.