Value Funds - Unlocking the Power of Value Investing
By Akhil Chugh
Date February 18, 2024
Mutual funds use various strategies to grow wealth. Some funds choose to invest in tried and tested large-cap stocks while others choose to invest in high-quality debt and fixed income securities.
But certain mutual funds stand out for their unique investment approach and unorthodox strategies. One of them is the Value fund!
The well-known phrase, “If you can’t handle me at my worst, you don’t deserve me at my best”, very well applies to a value fund.
Value investing has long been heralded as a timeless strategy for building wealth in the stock market. At its core, value investing seeks to identify stocks that are trading at a discount to their intrinsic value, providing investors with the opportunity to buy quality assets at a bargain. One of the most popular vehicles for executing this strategy is through value funds.
In this blog, we’ll delve into the world of value funds, exploring what they are and why they might be a valuable addition to your investment portfolio.
What are Value Funds?
A Value Fund is designed around a unique investment strategy known as “Value Investing”, popularised by legends like Warren Buffet. The strategy revolves around selecting stocks that are fundamentally undervalued in price.
When an investor (or a fund manager) adopts a value investing strategy, he looks for stocks that are undervalued and trade for less than their respective intrinsic values. The assumption is that these stocks are undervalued due to deficiencies in the market or investor ideology. Value fund managers are able to identify inefficiencies in these markets.
Theoretically, once these inefficiencies are corrected by the market, the value investor will gain from a share price increase.
There are many companies in the market whose stock price is not the true indicator of their worth. They are intrinsically more valuable and have a lot of potential to grow.
Therefore, a Value fund is an equity fund that invests in stocks of companies having ‘value’. Value fund invests in multiple companies that have long-term potential but are currently flying under the radar.
According to SEBI (Securities & Exchange Board of India), a Value fund is an open-ended equity scheme that follows a value investing strategy with a minimum investment of 65% in equity and equity-related instruments.
Many people are under the assumption that value investing means buying cheap stocks or penny stocks. But this is not true. Most Value funds have diversified portfolios with a significant presence of both large and mid-cap companies in their portfolios.
Features of a Value Fund
- Equity fund that invests across all market caps
- Invest in undervalued stocks with future potential to grow
- Offers a high dividend yield
- A long-term investment option to generate returns
- Heavily relies on judgement of a fund manager
Who Should Invest in Value Fund?
- Seasoned investors who understand macro trends.
- Investors with moderate to high-risk appetite who are ready to take selective bets for higher returns.
- Investors with a long-term investment horizon as a value fund relies on the future potential of undervalued stocks.
Benefits of Investing in Value Fund:
1. Lower Valuation Risk:
Investing in value funds can help mitigate valuation risk compared to growth or momentum strategies. Since value funds seek stocks that are trading at a discount to their intrinsic value, there is often a margin of safety built into these investments. This can provide a cushion against market downturns and volatility, reducing the risk of significant capital loss.
2. Diversification Benefits:
Value funds offer diversification benefits by investing in a broad range of undervalued stocks across different sectors and industries. This diversification helps spread risk and can enhance portfolio stability. By including value funds in a diversified investment portfolio, investors can reduce their exposure to specific market sectors or individual stocks, thereby improving risk-adjusted returns.
3. Long-Term Wealth Accumulation:
Value investing is inherently a long-term strategy, focusing on the fundamental value of investments rather than short-term market fluctuations. By adopting a buy-and-hold approach with value funds, investors can benefit from the power of compounding over time. As undervalued stocks appreciate and dividends are reinvested, the potential for long-term wealth accumulation increases significantly.
4. Contrarian Opportunity:
Value investing often involves taking a contrarian approach by investing in out-of-favor stocks or sectors that may be temporarily undervalued. This contrarian mindset can provide investors with the opportunity to capitalize on market inefficiencies and profit from the eventual reversion to fair value. By being patient and disciplined, value fund investors can take advantage of market dislocations and potentially generate outsized returns.
5. Inflation Hedge:
Value funds can serve as an inflation hedge due to their focus on tangible assets and strong fundamentals. Inflation erodes the purchasing power of money over time, but investments in undervalued stocks with solid earnings and dividends can help preserve wealth and maintain purchasing power in real terms.
Value funds offer investors a compelling opportunity to unlock the power of value investing and achieve their long-term financial goals. With their focus on undervalued stocks, diversification benefits, and potential for long-term wealth accumulation, Value funds can be a valuable addition to any investment portfolio.
Key Takeaways from Net Brokers:
- Value Funds are for long-term investments only – If a stock is undervalued, it is possibly because of being a cornered stock. It could take years for the market to realize a company’s true potential. Thus, for short-term gains, value funds are not exactly ideal.
- While value funds have a lower downside due to their investment in undervalued stocks, they can still be susceptible to value trap. The anticipated turnaround may never come forcing the fund to sell off the investment at lower or sub-optimal prices. Thus, Value funds are suitable for investors with high-risk appetite.
- Even if you are an aggressive investor, the exposure to these funds should be restricted to under 15% of your portfolio as they can be volatile at times.
- Investors should stay invested for at least 7 years to derive the maximum benefit from the entire investment cycle.
Before picking the Value fund, investors should ensure that the scheme is aligned with their investment objective, risk appetite & personalized asset allocation plan.
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