Are value mutual funds for you?

The equity markets in the last few trading sessions have become volatile. In such a situation, new investors are nervous as they are clueless about which side the markets will turn. They are afraid of committing to any mutual fund as any correction in the market may lead to a loss of capital. Hence, the risk-reward matrix is currently tilted towards risk.  

Nonetheless, there are funds with a mandate to invest in ‘value stocks’, which might appear to be a better bet now. These funds invest in companies that are fundamentally very strong, but for some reasons, their share prices are not reflecting their actual worth. It could be because of a temporary blip in company’s earnings or any other macroeconomic event that may have temporarily impacted the stock price. Hence, these funds invest in stocks that have high ‘margin of safety’. This criterion of stock selection and building of portfolio helps in protecting the downward risk. These funds also tend to do better when the market is trading at steep valuation. Nevertheless, there may be phases, especially during a bull run, when these funds may underperform other equity funds when the market chases growth. But in a growing economy like India, there are very few funds that focus on value investing. Less than 10% of Indian equity funds' assets are deployed in value-oriented funds. Rest of them are either 'growth fund' or blend of value and growth. 

As of now, there are five value funds in existence for more than one year. These funds have on an average generated return of 29.2%. However, the average may not reflect the true returns, since the range of returns on these funds is 17-43%. So, which key factor decides the returns on value funds? It is the market cap category of the fund that is a deciding factor in generating returns for a value fund. Therefore, funds investing in large-cap companies tend to generate lower returns as large-cap stocks in India are well researched, so identifying “value” in this space becomes difficult. But it is relatively easier to identify stocks at attractive valuations in the mid-cap and small-cap space. Therefore, if you are going to a value fund, it is advisable to go for funds that invest in mid-caps and small-caps. 

Nevertheless, none of the market cap categories can guarantee you better returns than the other. Hence, investing in both categories of value and growth funds can reduce the risk of losses and, therefore, it is advisable for new investors to avail both categories.