Many Investors have an objective to build wealth through their long-term investment portfolio and this can be done by choosing the right investment strategy. Value funds can be a good addition to your portfolio if you are among the mentioned category. These funds invest in companies that have growth potential in long term and can give amazing returns to the investors. In this article, we have discussed the meaning, workings, benefits, risk, and other important aspects related to value funds in detail and after reading them, you will be able to make a sound decision regarding which value fund to invest in.
WHAT ARE VALUE FUNDS?
These funds fall under the category of equity mutual funds that uses a value investment strategy which is a concept popularized by legendary investor Warren Buffett. This signifies to look for companies that the market underestimates. The ideology behind this approach is that you buy stocks of an undervalued company and hold onto them for a long term till the stock price catches up to its actual worth and you reap benefits. In simpler words, value investing is all about finding the bargains in the market that have the growth potential to generate decent and consistent returns later. A value mutual fund scheme concentrates its holding in these types of entities offering investors a focused way to own multiple value stocks under one place.
HOW VALUE FUNDS WORK?
Every mutual fund is managed by professional fund managers who decide the allocation & investment strategies of the fund. Here, the value fund managers use fundamental analysis to assess companies’ financial strength and health to conclude whether it is truly undervalued. This analysis looks at various aspects and metrics such as Price to Book(P/B) ratio, EPS, and Price to Earnings(P/E) ratio among others.
Talking about them in detail, EPS or Earning Per Share is a way to measure how profitable a company is based on its EPS of stock. The price to earnings ratio tells the ratio between the companies’ share price to its EPS and the Price to book ratio tells us the market value of a company as compared to its book value. Intra and Inter-industry comparisons can also be done by fund managers to ascertain appropriate investments to be included in the fund’s portfolio. Particularly, they look at things like dividend yields or return on equity of different companies. Though there is no certain and specific approach to opt for value stocks for inclusion in a fund, they are generally identifiable by High dividend yields, Low price to book value ratio, and Low price to earnings ratio.
Value funds can hold just a few or a large number of companies. Some value funds base their allocation on market cap and as a result, you may have funds that overlap across the different market cap.
ADVANTAGES OF VALUE FUNDS
Investors get exposure to a diversified portfolio through value funds as the allocation is made in companies across different sectors & market capitalizations.
Investment strategies adopted by fund managers of value funds invest in undervalued stocks which are less vulnerable.
Stocks that are included in value funds span across all economic industries and sectors which are often overlooked and this results to boost the market confidence in the underperforming stocks.
4. Steady growth:
These funds often grow steadily irrespective of the volatilities in the market. In the bearish phase, this can prove to be a sound investment option where fund managers can purchase stocks at a low price and sell them in the future at higher pieces as the market start recovering.
Value funds can add stability to the portfolio of investors to some extent. Since they consist of undervalued stocks, they can act as a cushion to the portfolio in case of the market crash and bearish phase.
Also Read: What is Portfolio - Meaning, Types, Management, Components, Objective, Steps to Build Portfolio
RISK RELATED TO VALUE FUNDS
1. Risk of Devaluing:
Value funds can devalue in a growth-oriented market, where high-priced shares are continuously traded more than the undervalued shares. Because of insufficient investment in high-growth stocks, these funds may underperform.
2. Value trap:
There is a possibility that some of the undervalued shares included in the value funds may not grow and appreciate at all and had false alarms on growth potential. In such a scenario, the managers may have to let go of these stocks at a loss after a long wait.
3. Time Factor:
The slow growth of these types of funds can be irritating and frustrating. It may be years before certain stocks see appreciation for their potential. Therefore, a lot of patience and time is required.
KEY ASPECTS TO CONSIDER BEFORE INVESTING IN VALUE FUNDS
1. Past Performance:
Investors must go ahead with an old fund that has the experience and lasted in the market. Nevertheless, you cannot simply look at past results and make a decision. Researching and analyzing the details and assets of the fund in parallel with past performance is the best exercise to do and make a decision.
Investors should always go for funds that offer diversification by investing in different industries and sectors. This is because diversification always reduces the risk by some points. Moreover, a fund that is concentrated toward a specific industry may result in a loss in case the industry doesn’t perform well.
3. Fund Managers:
The fund managers are one of the most important aspects of any fund as these are the people who will be handling your hard-earned money and taking decisions on behalf of you. You should be reasonably comfortable with the skills, ability, and knowledge of the managers that they will gauge the real worth of companies and you will be at ease with the decision they take on your investments.
4. Time Factor and Patience:
As discussed, value funds take a lot of time and test the patience of the investors before they give returns. So only those investors who have an appetite to swallow the time of years can cope up with these funds.
WHO SHOULD INVEST IN VALUE FUNDS?
Investors who are aware of the macro trends and looking for a long-term investment that can grow steadily can be ideal investors for these funds. Also, investors who have patience and belief in the value investing strategy and aggressive investors looking forward to take selective bets for higher returns can also go forward with value funds.
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