Value Funds: Bargain or Value Trap?

In a market where benchmark indices stayed resilient but nearly three-fourths of stocks delivered negative returns in last one year, value investing has quietly regained relevance. Value funds have held up better by buying fundamentally sound businesses when fear and pessimism push prices below intrinsic worth. This cover story explains how Indian value funds are actually constructed today and what truly drives performance beyond just past returns. It also highlights the key metrics and warning signs investors should track before allocating long-term capital[EasyDNNnews:PaidContentStart]

The Great Divide: A Market in Search of Value
The Indian equity market’s performance over the last year has been a tale of two cities. While the benchmark indices held up well and a handful of stocks delivered strong gains, the broader market picture was far less encouraging. Even though the Nifty 50 and Sensex posted returns in the higher single digits, overall participation remained weak.

An analysis of share price performance across nearly 2,100 listed companies over the past year shows that around 75 per cent of stocks delivered negative returns, with the average decline at about 28.1 per cent.

Yet, despite this tough backdrop, one theme that quietly stood out was ‘Value’. The value segment managed to generate positive returns, with value-focused funds benefiting the most from this shift.

Over the past year, value-oriented Equity Funds have shown their strength, delivering a positive return of 6.69 per cent despite a tough market environment. And this is not a one-off. Over the last three and five years, value funds have generated robust returns of 18.72 per cent and 17.8 per cent respectively, comfortably ahead of the benchmark, which delivered 15.73 per cent and 15.58 per cent over the same periods.

This consistency stems from a disciplined and time-tested approach: buying fundamentally strong businesses when they are temporarily available below their intrinsic value. The performance history reinforces the resilience of value investing and the patience it demands. For investors, it also provides an important margin of safety, especially when markets turn volatile.

This market recalibration has cleaved the market in two. On one side, we have high-growth sectors—power, electronics manufacturing, fintech, and quick commerce—that have been substantially re-rated and now carry what the report terms ‘valuation risk’. On the other side are traditional, low-growth sectors like lenders, FMCG, and Large-Cap IT, which have de-rated and now carry ‘growth risk’.

This divergence creates the central tension for every investor today. In a market where yesterday’s darlings look expensive and today’s laggards look cheap, where does the real opportunity lie? Is this the moment for value investing, the disciplined art of buying good businesses for less than they’re worth?

The Anatomy of an Indian Value Fund
While the underlying philosophy of value investing is universal, its practical application can differ significantly from one fund to another. In India, the Construction of a value fund portfolio reflects the fund manager’s unique strategy, risk appetite, and interpretation of what constitutes ‘value’ in the current market context. Understanding these nuances is critical for any investor looking to add a value fund to their portfolio.

Portfolio Construction Insights
A look at the data for funds in the SEBI ‘Value Oriented’ category reveals a surprising diversity in approach.
■ Valuation Metrics in Practice: As a starting point, nearly all value fund managers use foundational metrics like Price-to-Earnings (P/E) and Price-to-Book (P/B) ratios to screen for potentially undervalued companies.

■ The Style Box Dilemma: Here lies a critical insight for investors. According to a study, a significant number of funds officially categorised by SEBI as ‘Value’ actually have an ‘Equity Fund Style’ of ‘Growth’ or ‘Blend’. For instance, funds like Bandhan Value Fund and Axis Value Fund are all stylistically classified as ‘Growth’. This does not mean they are mislabelled; rather, it suggests their fund managers are applying value principles to identify reasonably priced companies within growth-oriented sectors or are blending different investment styles. This is a crucial distinction for investors who may be seeking a ‘pure’ value strategy.

■ Turnover and Patience: The portfolio turnover rate is a powerful indicator of a fund manager’s philosophy. It reveals how frequently the portfolio is churned. At one end of the spectrum is the traditional, patient buy-and-hold approach, exemplified by the Bandhan Value Fund with a very low turnover of just 35 per cent. At the other extreme is a tactical, quantitative strategy, as seen in the Quant Value Fund, which has an astonishingly high turnover of 96 per cent. This stark difference shows that some funds are making longterm, high-conviction bets, while others are actively trading to capture short-term valuation opportunities.

Selecting Value Fund For You
■ Assess the Fund Manager and Philosophy
The success of an active fund depends heavily on the manager’s skill. Look for seasoned fund managers with a consistent, long-term track record specifically in value investing. Read their commentary in factsheets and Interviews. Do they have a clear, disciplined philosophy for identifying undervalued opportunities and, just as importantly, for avoiding value traps? A manager who can articulate their process clearly is often one who follows it diligently.

■ Scrutinise the Expense Ratio
Costs matter—a lot. There is a clear-cut, consistent inverse correlation between expense ratios and performance of the funds; hence, the market regulator is also trying to contain this. Simply put, funds with lower costs tend to deliver better net returns to investors. The range in the value category is wide. For example, a fund like Mahindra Manulife Value Fund Dir Plan Growth has an expense ratio of just 0.52 per cent, while an active fund like the Union Value Fund Dir Growth charges 1.32 per cent for the month ending December 2025. Always compare a fund’s expense ratio to its direct peers to ensure you are not overpaying.

■ Beyond Raw Returns: Risk-Adjusted Metrics
High returns are great, but not if they come with terrifying volatility. Risk-adjusted metrics provide a more complete picture of a fund manager’s skill.
■ Sharpe Ratio: Measures the return generated per unit of risk taken. A higher Sharpe ratio is better.
■ Alpha: Indicates how much a fund has outperformed its benchmark on a risk-adjusted basis. A positive alpha is a sign of a manager’s stock-picking skill. For example, the DSP Value Fund has a very healthy Alpha of 1.41 at end of 2025. n Beta: Measures a fund’s volatility relative to the market. A Beta below 1.0 suggests the fund is less volatile than the market. The Quantum Value Fund - Direct Plan, for example, has a low Beta of 0.81, indicating it has historically been more stable than its benchmark.

Market Regimes: Where Value Funds Win and Where They Struggle
No investment strategy can outperform in all market conditions. A fundamental part of successful long-term investing is managing expectations, which begins with understanding the typical economic and market environments where a chosen strategy, like value investing, tends to thrive or lag. This knowledge helps investors stay the course during periods of underperformance and recognise when conditions are favourable.

The following table outlines the market regimes where value funds typically excel and where they often face headwinds:

Understanding these regimes is not about timing the market, but about building a resilient, all-weather portfolio. This brings us to the practical application of value funds within an investor's overall asset allocation.

Practical Portfolio Use-Cases for Value Funds
While timeless in principle, the application of value investing requires a framework adapted to today’s markets. Value funds are a strategic tool, not a universal holding. Their effectiveness depends on how deliberately they are deployed within a portfolio to exploit specific market behaviours and complement other assets. Below, we outline how value funds can serve distinct strategic purposes for different investors.

Strategic Allocation 1: The Stabilising Core (Moderate Risk Profile)
■ Investor Profile: Seeks steady, resilient growth over 10+ years. Prioritises capital preservation and is wary of speculative bubbles. Comfortable with market cycles but aims to mitigate severe drawdowns.
■ Equity Allocation Strategy:
■ Core Anchor (40-50 per cent): Blend of Large-Cap Value and Large-Cap Index Funds.
■ Strategic Complement (30-40 per cent): Flexicap/ Diversified Growth funds.
■ Satellite Allocation (10-20 per cent): International or Thematic funds for growth exposure.
■ Rationale: Here, value funds provide factor diversification and defensive resilience. They historically exhibit lower volatility in downturns compared to the broad market, offering a ballast. In a portfolio core, they counterbalance growthoriented holdings, aiming for more consistent compounding. This is less about 'beating the market' and more about building wealth through reduced portfolio fragility across full market cycles.

Strategic Allocation 2: The Growth Complement (Aggressive Risk Profile)
■ Investor Profile: Has a high-risk tolerance and a long horizon (15+ years). The portfolio is growth-oriented but recognises the peril of single-factor concentration (e.g., only growth or momentum).
■ Equity Allocation Strategy:
■ Growth Engine (60-70 per cent): Growth, Mid-Cap, and Small-Cap funds.
■ Cyclical & Diversifying Hedge (20-25 per cent): Value funds.
■ Opportunistic/Tactical (10-15 per cent): Highconviction thematic or alternative strategies.
■ Rationale: For the aggressive investor, value funds act as a strategic hedge and cyclical play. Growth and value leadership rotates with economic conditions. A dedicated allocation to value ensures exposure to sectors that may lead during periods of rising rates or economic recovery.

In India, a Value Fund is an open-ended equity Mutual Fund that follows a value investing strategy, meaning it seeks companies trading below their intrinsic worth and typically builds positions with a medium-to-long holding horizon; under SEBI's scheme categorisation framework, it must invest at least 65 per cent of its total assets in equity and equity-related instruments. A Contra Fund, while also an equity scheme with the same minimum 65 per cent equity allocation, takes a contrarian approach by deliberately positioning against prevailing market narratives, buying fundamentally sound stocks that are temporarily out of favour and exiting when sentiment and valuations normalise. The practical difference is that value investing is primarily anchored in price versus fundamentals (cheap relative to intrinsic value), whereas contra investing is anchored in market behaviour (cheap because the crowd dislikes it right now), even though the two can look similar in portfolios during certain phases. From a regulatory standpoint, SEBI's 2017 categorisation reforms were designed to reduce product clutter and improve clarity, leading to the convention that an AMC could offer either a Value Fund or a Contra Fund within the equity category to avoid two strategies being marketed separately while ending up looking alike. More recently, in the month of July 2025, SEBI, in a consultation paper published on its website, proposed allowing mutual funds to run both value and contra schemes, provided the overlap between their portfolios does not exceed 50 per cent.

Your Decision Framework for Value Funds n Know Thyself: Value funds are for patient investors with a 5+ year horizon. They are not a tool for chasing short-term market momentum. n Look Beyond P/E: True value lies in strong fundamentals— healthy balance sheets, stable cash flows, and a competitive moat—not just a low price tag. n Embrace Cyclicality: Understand that value investing goes through cycles. It will underperform in growth-led rallies but provides critical downside protection in downturns. n Beware the 'Value' Label: Scrutinise the portfolio. Many funds in the value category blend styles. Decide if you want a pure value fund or a blend. n The Manager Matters Most: The success of an active value fund depends almost entirely on the fund manager's skill in research, capital allocation, and avoiding value traps. n Check for Red Flags: Regularly monitor for style drift, persistent underperformance versus peers, and excessively high turnover or fees. A good fund should remain true to its label. n Use as a Diversifier: Value funds are an excellent tool to balance a growth-heavy portfolio, providing exposure to different economic factors and market conditions. n Price is What You Pay, Value is What You Get: The ultimate goal is to buy good businesses at a sensible price. Never confuse cheapness with value.

Implementation: Beyond the Basic SIP
While Systematic Investment Plans (SIPs) are an excellent default for building a position in value funds, averaging cost through periods of underperformance, investors should also consider tactical lump-sum allocations. These can be deployed when value spreads (the valuation (PE) gap between value and growth stocks) are historically wide, signalling a potential mean-reversion opportunity. This data (PE differential of Value and Growth index) can be computed using exchanges' data regarding such indices. A hybrid approach, a steady SIP base with occasional tactical additions, can optimise entry points.

Essential Monitoring: Key Risks in a Modern Context
A 'set-and-forget' approach is inadequate. Proactive oversight should track:
1. Style Drift: Does the fund manager begin chasing expensive growth stocks, diluting the value mandate?
2. Quality Erosion: Are holdings truly undervalued with sound fundamentals, or are they 'value traps' with broken business models?
3. Macro Sensitivity: Recognise that certain value sectors are highly sensitive to interest rates and economic cycles. Ensure this aligns with your macroeconomic outlook.
4. Relative Opportunity Cost: Monitor performance relative to broader benchmarks over a full market cycle (3-5 years), not quarterly. Persistent, unexplained underperformance may warrant review.

In summary, value funds in a modern portfolio serve as either a stabilising core for risk-aware investors or a strategic diversifier for growth-oriented ones. Their success hinges on intentional allocation, disciplined entry, and vigilant monitoring for the specific risks that accompany the value style.

Risks, Red Flags, and Quarterly Monitoring Checklist
Successful long-term investing is not a 'set it and forget it' activity. Disciplined, proactive monitoring is essential to ensure your chosen value fund remains true to its mandate and continues to deserve a place in your portfolio. This checklist provides a practical tool for investors to regularly assess their holdings and spot potential trouble before it becomes a major problem.

1. The Value Trap: Review the fund's top holdings. Are there stocks that have been trading at low valuations for years without any clear catalyst for a re-rating? A portfolio full of such names is a major red flag.

2. Style Drift: Is the fund, advertised as 'value', consistently holding high P/E, high-momentum stocks that belong in a growth portfolio? Compare the fund's portfolio characteristics (average P/E, P/B) against its stated mandate and its value-oriented peers.

3. Persistent Underperformance: While short-term underperformance is expected, is the fund consistently lagging not just growth indices but also its value-oriented benchmark and peer group over a rolling 3-to-5-year period? This could signal a flawed process.

4. Fund Manager Change: Has the seasoned manager who built the fund's track record departed? A new manager could bring a completely different philosophy. This could effectively change the nature of your investment.

5. Excessively High Turnover: A patient, long-term value strategy should have a relatively low turnover rate. A very high rate may indicate a shift towards short-term, tactical trading, which increases costs and can deviate from the core value philosophy. The Quant Value Fund's 261 per cent turnover is a notable outlier representing such a strategy.

6. Bloated AUM: Has the fund's Asset Under Management (AUM) grown so large that it is struggling to invest in smaller, more nimble undervalued companies? This can force the manager into less attractive, widely owned large caps, diluting potential returns.

7. High Expense Ratio: As highlighted by academic research, costs are a direct drag on returns. Is the fund's expense ratio creeping up or significantly higher than peers with similar AUM and performance? This erodes your net gains.

8. 'Closet Indexing': Does the fund exhibit a very low tracking error and an R-Squared above 0.95 relative to a broad market index? As the Wharton analysis warns, this might be a red flag that you are paying active management fees for what is essentially an index fund.

9. Over-Concentration in a Single Struggling Sector: While concentration on best ideas can be a positive, is the fund's performance overly reliant on the fortunes of one struggling sector? This increases risk and makes the fund vulnerable to sector-specific headwinds.

10. Unclear Communication: Does the fund house provide clear, consistent, and insightful commentary on its strategy and holdings in its monthly factsheets? Vague or boilerplate reasoning for portfolio decisions can be a sign of a weak investment process.

Conclusion: Finding True Value in a World of Noise
In a market landscape increasingly dominated by short-term noise and momentum-chasing, value investing remains a powerful, time-tested anchor for the disciplined, long-term investor. It is a strategy built not on speculation, but on the enduring principle of buying good businesses at a fair price. However, its successful implementation demands patience, a clear understanding of its cyclical nature, and a rigorous analytical framework. As we have explored, 'cheap' does not always equal 'value'. The critical task for the savvy investor is to learn how to distinguish between a genuine opportunity born from temporary market pessimism and a value trap destined for permanent underperformance. By scrutinising the fund manager's philosophy, understanding the fund's construction, evaluating risk-adjusted performance, and diligently monitoring for red flags, you can harness the full potential of value investing to build resilient, long-term wealth.

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