Is It The Right Time To Invest In Value Funds?

Value is a precious asset and more so given today’s precarious times. Having faith in your investment to create long-term wealth might be jolted due to a slump in the global markets, but it also presents the right opportunity to devote your finances to companies with good fundamental values. Vardan Pandhare decodes the importance of having a value fund in your portfolio

"If you are shopping for common stocks, choose them the way you would buy groceries, not the way you would buy perfume." 
- Benjamin Graham 

Benjamin Graham, a renowned influencer investor of the 20th century, was the one who created the concept of value investing. Over the years some of the most successful investment gurus, including Warren Buffet, have used the same principle to create enormous wealth. However, with the emergence of financial syndicates offering various investment avenues, value investing is now not just limited to individual investors. In the last decade, mutual funds too have been following the principles related to picking value funds. In fact, in the post-pandemic era, market participants have started speaking more about fundamentals and valuations. Such discussions will only grow in the coming days since the market is presently grappling with a lot of uncertainties. No wonder then that value funds are back in the reckoning with several seasoned and new-age investors who want to learn more about it. To be fair, the last two years were kind for value investing admirers as only a handful of heavyweight stocks pulled the market higher. It was the time when value fund managers and experts were grumbling that no one was paying attention to valuations.

Especially so the first time investors who were ready to pay a premium to own a few blue chip stocks which were driving the market ahead. However, the trend was soon reversed and the bull phase started to lose steam in the second half of 2021. The markets, both globally and in India, were up and the surge was not driven by a few conglomerates. Many premium and discounted stocks participated in this broad-based rally. Thanks to these market movements, value funds also managed to stage a great comeback. But this market atmosphere taught investors a few important value-investing principles.

Decoding Value Funds
So, coming to the moot question that must have arisen in your mind: can value funds create long-term value for your money? To answer your question in simple terms, Yes, valuethemed funds strive to identify stocks that are yet to be discovered by market participants, and an important selection criterion is sound fundamentals of the stock. Fund managers believe that at a certain time the market would discover these hot picks and when that happens, the fund would generate good money.

Benjamin Graham in his book titled ‘The Intelligent Investor’ has rightly said, “A stock is not just a ticker symbol or an electronic blip. It is an ownership interest in an actual business with an underlying value that does not depend on its share price.” Along similar lines, the idea behind value investing is that for numerous reasons the market has some natural inefficiencies that allow particular stocks to sell at rates below their actual value. This is where a value fund manager identifies the inefficiencies in these markets and bets on the winning horse. In layman's language, value is cheaper than its intrinsic value.

This cheapness can be attributed to two reasons. One is from the historical valuation perspective and the other set of values comes from an emerging sector or segment which is small but can have exponential growth. Identifying them at an early stage and at a discount so that the value can become expensive over a while is the key to this form of investing. The idea behind a value investing strategy is that the share price will increase after the market understands the actual value of these stocks which will benefit value fund investors as they stand to gain from their investments.

Points to Remember
Value stock picks are often well-established companies giving dividend payments to their investors. Value funds are typically utilised as allocations for long-term investments that can grow steadily over time. Thus, investment in the value fund is often linked to investment due to diligence and patience.

Value Funds or Growth Funds
Today, most asset management companies offer two types of mutual funds – value funds and growth funds. The aim of all the mutual fund companies is to grow your investment. Each fund offers different kinds of investing options to suit various types of investors. As a prudent investor, the consistent ambition is to have a settled and diversified portfolio that provides good growth at regular intervals. And as the names indicate, growth funds focus on consistent growth while value funds concentrate on giving value and regular returns on your investment. Both growth and value funds are perfect for an investment portfolio as they balance out the risk associated with each other.

"Everyone has the brain power to make money in stocks. Not everyone has a stomach." - Peter Lynch

Deep Dive into Value Funds

Here are some qualities of value mutual funds:

1. Asset Allocation: The Securities and Exchange Board of India (SEBI) recommends that value mutual funds must allocate around 65 per cent of their investment corpus to stocks.
2. Risk-Reward Ratio: As the underlying securities of value mutual funds predominantly include equity, their performance might get hampered by volatile market conditions. Investors should be well aware of this critical factor before investing. Nevertheless, as the underlying stocks are already undervalued or available at a discounted rate, they can maximise portfolio returns in the long term. Additionally, there’s also a lesser risk of capital loss with value funds in an uncertain market.
3. Taxation: Value mutual funds fall under the equity mutual funds category and draw the same taxes accordingly.
4. Short-Term Capital Gains: Gains made from the sale of units with a holding period of less than one year are taxed at 15 per cent.
5. Long-Term Capital Gains: If an investor redeems held units after a year, then earnings up to Rs 1 lakh are exempted from taxation. But, a Long-Term Capital Gains Tax of 10 per cent is applicable on the amount exceeding Rs 1 lakh.

Discovering Value Funds

Discovering the best value stocks requires seasoned skills, analysis and market awareness, and can be overwhelming at times. As far as big fund houses are concerned, after conducting extensive market research and analysis, proficient fund managers handle these scheme portfolios, avoiding the risk burden for an investor. As a suitability factor, value funds are for investors with a long-term investment horizon, preferably more than five years. Having said that, investors need to consider certain aspects before finding out which is the best-suited value fund for them. Some of the things that you should consider before investing in value mutual funds include:

✓ Investment Goal: The investment goals of every individual are different, and not all value fund schemes can match the investors’ financial objectives. While some schemes could deliver significant returns at a three year-point, others might need seven years to generate maximum returns. It’s essential, therefore, to estimate your requirements and find a value fund scheme aligning with your goals.
✓ Risk Appetite: The risk level of each scheme is not the same. One fund might be more perilous than the other, depending upon the performance of the underlying stocks. Hence, you need to assess your risk profile before investing in your favourite value funds.
✓ Expense Ratio: This is the charge levied by an asset management company (AMC) on investors to cover its operating and administrative expenses. You must make sure to compare the expense ratio of different schemes and consider other factors before parting with your savings.
✓ Expertise of Fund Manager: When it comes to managing value mutual funds, the respective fund managers need to have meticulous knowledge and market awareness. Also, they need to have the skills to make suitable decisions at the right time. Hence, the track record of a fund manager is a vital aspect to consider when investing in value funds.
✓ Performance History: The performance of a value fund since its beginning reflects whether it has been able to accomplish its objective. Hence, one must consider the historical data of a fund when investing in this type of scheme. However, do note that a fund’s past performance may not mirror the same performance in future.
✓ Direct or Regular Plan: Value mutual funds often offer two investment plans for investors – direct and regular. The first plan is offered by an AMC directly and does not involve a third party like a broker or distributor. Conversely, investors have to subscribe to a regular plan via distributors or brokers, which involves commission and brokerage. Due to this obligation, regular plans have a higher expense ratio and report a lower NAV than direct plans.

Benefits of Value Funds

Here are some of the most important advantages that accrue from investing in value funds:

1. Portfolio Diversification: Value funds invest in discount ed stocks available in different sectors. It helps in expanding your portfolio with limited exposure to stocks along with a significant risk-reward ratio.
2. Minimum Downside Risk: The downside risk and the level of volatility in value funds are lower when compared with other types of equity mutual funds. Since these stock picks are already undervalued, they are less impacted in a bearish market.
3. Good Growth Potential: Value funds have the potential to multiply investors’ wealth significantly and maximise portfolio value over the long term.

Do Value Funds Underperform?

Yes, value funds tend to deter from the investment goals when the market momentum is extremely bullish as the atmosphere is in favour of growth investing. This is the time when people are willing to pay a higher price in expectation of higher growth or return on investment. Take the example of the extensive bull run that was witnessed till the second half of 2021. During the period, the small-caps and Mid-Caps coped better and, as a result, the small-cap, mid-cap and flexi-cap funds outperformed the value funds.

But, it is remarkable that many smaller companies also passed the litmus test of value investing when the Indian equity markets corrected by over 20 per cent at the start of the pandemic in India in March 2020. Value funds underperformed the broader markets only when a handful of stocks drove the index returns. This is the time when investors as well as fund managers chase stocks showing earnings’ visibility so as to ride the high growth momentum.

Conclusion

With ongoing geopolitical tensions between Ukraine and Russia, rising inflation, an aggressive monetary policy stance of the Federal Reserve and the possibility of a slowdown in world economic growth, wealth creation in the equity market may not be easy this year. The bulls clearly seem to be exhausted as the bear grip has tightened over most of the global stocks. As more central banks hike interest rates to tame rising inflation, the raging bulls have per force slowed down. In 2022, as a mutual fund investor, your patience and persistence will be the key

The recent drop in some of the overvalued stocks, including some of the newly listed companies, has exactly shown us how vulnerable the phase of risk aversion could be for pricey growth stocks. Owing to these developments, value funds would be a better fit for your portfolio. Keep in mind that when the markets take more significant risks, growth surpasses. When markets turn conservative, value investing tends to do well. Hence, make sure that you hold an all-weather portfolio with a mix of growth as well as value funds.