Value investing in shares is an investment theme which was developed in the 1920s by finance professor Benjamin Graham. According to value investing theory, the true value of a share can be determined through research. So, investors could identify and buy such shares priced well below their true value or intrinsic value, and hold them for the long-term. Based on this investment style, value mutual funds are being floated. Let us discuss the same in detail.
Value mutual funds
A value mutual fund is a type of equity fund that invests in shares that trades lower than the company fundamentals which is considered as undervalued. Fund managers of such funds identify undervalued companies by considering their business model, financial performance, competitive position, management team, etc. Accordingly, if the company’s current market price is less than its intrinsic value, then it is considered to have value. Generally, value funds are open-ended.
For whom is it suitable?
Value funds appeal to investors because they invest in companies with a positive track record in the past and have a great earnings potential and such companies have strong fundamentals. Generally, value funds are ideal for aggressive investors who know macro trends, willing to take selective bets for higher returns, looking to diversify their portfolios for long-term goals and most importantly, have faith and patience in the value investing strategy.
As the value fund’s investment strategy focuses on undervalued stocks, it is less vulnerable to the market fluctuations. The shares in the value fund span across all economic sectors and is thus well-diversified. Value funds invest only in those shares which are currently trading at less than their intrinsic value and so they generate profits without worrying about market productivity. Similarly, those investors who have high exposure to growth stocks should invest in value funds to ensure a stable return on their investment in any market cycle.
Factors to consider
Consider the past performance of the value fund over the past five years. Check how the fund manager manages the investment objective of the fund through various market cycles without deviating from the value investing philosophy. Investors should stay invested for at least three to five years to gain substantial returns. This is important because certain shares are available at lower prices due to certain ongoing market conditions of the respective industry.
Sometimes, value funds might choose to invest in undervalued shares in large cap or mid-cap companies only. Unless you are looking for an exposure to companies which belong to a specific market capitalisation group, look for a value fund which diversifies across various market cap. The major advantage of value funds is that it has no bias. The no bias approach tends to save investors from possible mistakes if anything goes wrong.
Tax implications, risks
If the units of mutual fund are sold after one year from the date of investment, long-term capital gains up to Rs 1 lakh are tax exempted. And, the gains more than Rs 1 lakh are taxed at 10%. In case the units of mutual funds are redeemed or sold within one year of investment, the gains are taxed at 15%. One of the main risks associated with value investing strategy is that in case of wrong selection of a share, investors need to hold on to the shares for an infinite period of time. Thus, investors should be prepared to digest moderately to high losses even when the market performance is doing better.
To conclude, value fund investment is all about picking a trustable company, knowing the intrinsic value of stocks and being a diligent investor to make profits and create wealth.
The writer is a professor of finance & accounting at IIM Tiruchirappalli. With inputs from A.Paul Williams, research staff at IIM Tiruchirappalli