Value Mutual Funds – Definition, Advantages & Should You Invest in Them?
Last Updated : June 24, 2020, 5:38 p.m.
There are two major styles or strategies of investing in stocks – Growth and Value. Growth strategy is buying stocks that offer high growth potential albeit at higher valuations. This means if you want to buy a stock X which has the potential to grow at 20% per annum but is available at a higher valuation, you will still go ahead and buy it. The valuation of a stock is calculated by various ratios such as PE (Price to earnings), PB (Price to Book) and EV/EBITDA (Enterprise Value/ Earnings Before Interest, tax, depreciation and amortization.
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On the other hand, value investing means buying a stock at low valuations, the growth potential might not be very high but low valuation offers the potential to make money with a rise in prices. Value investing has a direct correlation with value mutual funds, let us understand how.
What is a Value Mutual Fund?
Value mutual funds are a type of open-ended equity fund that follows a value investing style. As explained earlier, value investing is an approach where the fund manager buys beaten-down stocks, which are available at a low valuation. These stocks might not necessarily offer high growth potential, but the cheap valuation makes them a good buy with potential upside in the future.
It is like buying a piece of real estate which is available very cheap today but might not have a high growth potential in the near future. However, if some positive events take place around that land/property like some commercial activities, it could lead to a re-rating of that real estate and eventual increase in prices.
Similarly, there are companies that are out of favour currently. This could be due to various factors such as a downturn in that sector, temporary issues with the company, or regulatory changes. All these would lead to a fall in the price of that stock and make it a value buy. Fund managers in value mutual funds try to pick such stocks so that when the turnaround happens these funds deliver good returns.
What are the Advantages of Value Mutual Funds?
The biggest advantage of value mutual funds is that the portfolio comprises stocks available at a cheaper valuation or discount, thereby promising high returns in the future. Funds that follow a growth style of investing are not able to buy beaten-down stocks and high valuations of these stocks could lead to a fall in the fund’s NAV when equity markets correct. Value mutual funds also offer a limited downside or probability of negative returns since the price is already down significantly.
Should You Invest in Value Mutual Funds?
Investment in value mutual funds should be done keeping certain important factors in mind. These are:
Time Horizon – You should have a long term horizon (minimum 5 years) when investing in value mutual funds since it takes time for a sector or company’s business to revive after it has gone through challenging times. One should not invest with the expectation of quick returns in these funds.
Track Record – Value investing is not easy since you need to have the patience to buy an under-performing fund and hold on to it till it revives. Therefore, a fund manager’s role in managing such funds is key. One should invest in those value mutual funds that have a long term track record (10 years and more) and seen different market cycles.
Portfolio Allocation – The allocation you have to value mutual funds should be limited to a certain percentage and you should not over-allocate to these funds. In Indian stock markets, the growth style of investing has done better than value and most equity mutual funds follow a growth style.
Diversification – You should invest in a value fund that is diversified and not concentrated in a few sectors or market caps. It is ideal to invest in a value fund that invests across cap curves-large, mid & small. Also, value stocks are available in almost all sectors at different times in markets.
Conclusion
Value investing is the oldest investing style in the world. Benjamin Graham- a famous U.S. investor is considered as the father of value investing, he laid down value investing principles decades back. One of the richest and famous investors in the world-Warren Buffet is a value investor and has made fortunes by investing in beaten-down stocks. However, investing in value stocks or value mutual funds needs a strong conviction and temperament to buy when these companies or funds are not doing well. We recommend investing a small portion of your portfolio in value funds and sticking to other equity funds that largely follow a growth style of investing.
