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Equity markets have been witnessing a correction since the beginning of 2018. Many stocks plunged to their 52-week low during this period. Despite sharp volatility, many mutual funds with exposure to growth stocks continued to grow at a steady pace. Some of these stocks sustained growth even as they traded at high valuations. Meanwhile, value-oriented funds were among the worst performers during this period.
[Read: Growth v/s Value Investing: Which Is Better Of The Two In Current Times?]
Value funds look to discover undervalued stocks, i.e. stocks that are trading below their intrinsic/fair value, but with strong fundamentals, and hold them till their value is realised. Value funds can offer a better risk-reward potential because they are better positioned to manage the downside risk during a market fall, but they may not participate well during a bull run.
The correction phase has provided the fund managers a good opportunity for value hunting.
The fact is, it's important to pay the right price for the right stocks. This is precisely what the famous quote: "Price Is What You Pay, Value Is What You Get", by the legendary investor Warren Buffett conveys.
Table: Value Funds have performed poorly in the recent years
Returns are compounded annualised
Data as on November 28, 2019
(Source: ACE MF)
Most value funds have been in the red over the last two years which has impacted long term returns. Only a few funds managed to outperform S&P BSE 500 - TRI index. Funds with higher exposure to broader market caps, particularly small caps, have been the worst affected whereas, those with higher exposure to large caps have fared better.
[Read: Why You Should Not Ignore Worthy 'Value Funds' Now]
Recently the market has seen few instances of rally where the Sensex and Nifty 50 touched record highs. As a result, value funds witnessed some improvement in performance though many funds are yet to recover.
Since the rally was despite any substantial improvement in corporate earnings or vital economic indicators, growth stocks were the major beneficiaries.
[Read: Are You Holding The Worst Performing Schemes In A Market Rally?]
India's GDP has reached its 26 quarter low of 4.5% y-o-y growth in Q2 FY20. Low Manufacturing and agricultural output, muted consumption, gross fixed capital formation, and export growth have pulled down the growth. Smaller sized companies face greater risk during such economic slowdown. Consequentially, this means that corporate earnings could continue to deteriorate and it could be a while before the value funds stage a comeback.
However, in the absence of better corporate earnings and improvement in vital economic indicators, at some point stocks trading at high valuations may begin to slip but strong businesses helmed by a well-built management team available at attractive valuations might hold firm.
The government has taken several measures in the recent past to boost economic growth. As the economy recovers, investments in value funds may pay off. Currently, valuations in mid and small caps look attractive. In case of large caps some of the stocks are at high valuations, but these stocks are a handful. Thus, there is value buying opportunities across market caps.
Graph: Valuations in mid-caps look attractive
Data as on November 29, 2019
(Source: nseindia.com)
As the fund managers of value funds invest in undervalued stocks, some of their bets may not pay-off immediately. Thus, value funds can underperform over the short to medium term. Then again over the long term, value funds can generate returns in line with growth funds or even outperform them.
Invest in value funds only if you can handle an extended period of underperformance and your investment horizon is more than 5 years. You can opt for the systematic investment plan (SIP) route to counter volatility and benefit from compounding of wealth.
Each value fund follows a different market cap bias - some have relatively higher exposure to mid and small caps. Therefore, assess your financial objective, risk appetite and investment horizon before investing in any scheme.
Further, to identify the best value funds, avoid relying excessively on past performance. The top performing funds of the past may not be the top performers in the coming years.
Invest in schemes that perform well across market cycle when compared to benchmark and category peers and have a good track record of handling downside. Make sure to invest in worthy value funds that stay true to its mandate of picking undervalued stocks with strong fundamentals.
[Read: Selecting Mutual Funds Carelessly Can Cost You Dear]
Ideally, the fund manager of a value fund should be following a buy-and-hold investment strategy to derive the full potential of the stocks in the portfolio and maintain a low portfolio turnover ratio.
Both growth funds and value funds have their pros and cons. To get favourable returns across market phases and cycles, invest in a mix of growth and value style funds based on your personalised asset allocation plan.
Want to learn more about value investing? Download PersonalFN's Guide to Value Investing with Mutual Funds
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