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WHAT IS VALUE FUND: MEANING, BENEFITS AND MORE?

You must have heard the terms like value investing and growth investing for a long time. For instance, when it comes to direct equity investing, most people are familiar that a growth investors looks for high growth, even at the cost of high P/E ratios. On the other hand, a value investor looks at deep value at low P/E valuations.

When it comes to mutual funds, that is approximately what a value fund also means. It is a fund that looks for deep value in the markets. Let us look at the concept of value funds in much greater detail.

WHAT IS A VALUE FUND?

In a way, value fund buying is like looking for discounts and bargains in shopping. Peter Lynch used to say that investors should buy equities the way they buy groceries, not the way they buy perfumes. In other words, investors must look at discounts and bargains in stocks too. The irony is that bargains are frequently available, it is just that investors either ignore these bargains or prefer to buy high priced stock that are the flavour of the day.

A value investors is like a savvy shopper adopting the attitude of patience till discounts. Why pay more for goods which you can get at a much lower rates in a bargain. That approach is called value buying. The fund that adopts this kind of an approach to investing is called a value fund. Value funds give you durable long term outperformance for a much lower price. A value strategy may not work all the time, but in the long run, if a few of these value picks turn out to be multi-baggers, your life is made. That is the idea of a value fund.

Scheme Name NAV Direct Return 1 Year (%) Direct Return 3 Year (%) Direct Return Since Launch Direct Daily AUM (Cr.)
DSP Value Fund 13.16 21.83   23.78 593.82
L&T India Value Fund 61.2 29.52 18 18.91 7,685.02
ICICI Prudential Value Discovery 271.86 35.22 21 18.1 22,981.22
IDFC Sterling Value Fund 95.29 41.07 21 17.19 4,446
Union Value Discovery Fund 17 24.32 17 17.15 135
Aditya Birla Sun Life Pure Value 76 23.57 12 16.61 3,956.76
Tata Equity PE Fund 208.91 20.55 14.35 16.52 4,936.08
HDFC Capital Builder Value 459.39 25.55 13.99 15.89 5,228.74
Nippon India Value Fund 129.3 29.84 20 15.35 4,353.12
JM Value Fund 54.63 23.83 17.66 15.33 155.46
IDBI Long Term Value Fund 16.25 24.24 15.95 14.45 102.05
Templeton India Value Fund 419.79 27.81 16.87 13.93 622.46
Quantum Long-term Equity 75.1 15.59 10.9 13.39 863.31
UTI Value Opportunities 103.64 21.2 17.87 13.38 6,523.16
Indiabulls Value Fund 18.84 22.97 14.76 10.16 10.85

The above table captures the best performing value funds in India based on AMFI data. We have considered the returns since inception as the benchmark and this is a good measure since majority of the funds have been around for more than 10 years in this case. 

UNDERVALUED STOCKS AND VALUE FUND INVESTING

To summarize what value investing is all about; it is the approach of looking for good businesses that are trading cheap. When we say cheap, we mean in terms of P/E ratio, P/BV ratio, EV/ EBITDA etc. Value funds heavily rely on the concept of intrinsic value of the fund or the true value of stocks. When the intrinsic value of a company is widely misjudged or not realised by the market, or it is being consistently ignored or undervalued, then the stock price is well below its true value. When the market realises this hidden potential, the up move in price will compensate for all the patience. A rerating of stocks on the positive side can mean huge value. For example, how specialty chemicals companies were re-rated.

WHY DO STOCKS BECOME UNDERVALUED?

When you look for undervalued stocks or value stocks, there is one major risk. You could be chasing a false mirage. For example, a stock may be cheap because of huge debt or due to a shift in the industry. This are called misleading value stocks. Let us look at reasons why stocks tend to genuinely become undervalued over a period of time.

  1. Stocks can become undervalued if there is an overreaction to bad news. For instance, large institutional investors may decide that the sector is likely to go through a long down turn. In such cases, the P/E ends up being too low. An example is that of PSU banks in the current market conditions.
  2. Quite often it is plain market irrationality. Investors use metrics like P/E ratio, price to book, enterprise value, dividend yield, profit margins, ROE, ROCE etc. Such variables can be negatively inclined for a long time. In fact, it can be a vicious cycle. People have low belief so they assign low P/E and hence it remains unattractive.

As stated earlier, one has to beware of value traps while adopting a value investing strategy. A stock may appear cheap but for good reason. Such a stock may never move up and you may end up with an opportunity loss. One golden runs is that when you buy a value stock, keep some triggers and a time frame hand. If it is not working, just exit. The logic applies to investing in value funds also.

HOW TO MAKE THE BEST OF A VALUE FUND?

Here are some basic things for you to understand about investing in a value fund. For instance, a value-based strategy will pay off only over a longer period. When you invest in a value fund, given enough time for the story to play out. A short term approach of 1 year can be quite myopic since such stories typically play out over a period of 5 years or more.

An important point to remember is that in a bull market the value funds will invariably underperform. In such a market, there will be a set of favoured growth stocks or hot sectors that will run up swiftly. Even though these growth stocks may not be cheap, it still finds buyers at higher levels in the hope that high growth rates will sustain. For the same reason, during market downtrends value funds keep losses to a bare minimum. However, value funds tend to perform best when the markets are sideways and without direction.

Finally, remember that investing in value funds requires patience, perseverance and a higher risk appetite. Growth investing is simple as you are just riding the trend. As long as the trend does not shift, you are very likely to make money. In case of value funds, you are actually betting on a trend shift. That is what makes it more complex.

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