Value funds: Patience of investment

Value funds are typically used as allocations for long-term investments

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A value fund is a fund that follows a value investing strategy and seeks to invest in stocks that are deemed to be undervalued in price based on fundamental characteristics. Value investing is often compared with growth investing, which focuses on emerging companies with high growth prospect.

Value managers select value fund stocks based on the basic features of the intrinsic value of a stock. Value funds are typically used as allocations for long-term investments that can grow continuously over time. Thus, investment in value funds is often connected with due diligence and patience of investment.

Muthukrishnan L, Independent Financial Advisor Muthukrishnan L, Independent Financial Advisor

There are two important principles used when adopting the value investing method for stock selection—Intrinsic Value and Margin of Safety. The stocks are selected that trade at a discount to their intrinsic values

The second important principle is to have a high Margin of Safety. It indicates the difference between intrinsic value of stock and market value. The higher the difference, the higher the margin of safety

There are various ways in which value stocks can be identified. They can be identified by financial metrics such as the Price to Book Value (P/B) or Price to Earnings (P/E) ratio.

Studies have shown that famous value investors have underperformed the markets during roughly one-third of their investing career. This under-performance to achieve long-term outperformance is a critical part of value investing. The reason for the temporary under performance is that the value picks bought, are perceived in a negative light initially owing to various perceptions and hence undervalued. Most of the times, markets discover the true value of the stock while at times, it takes longer than expected. This can lead to significant periods of underperformance. It has been observed in the past that investing in such potential ideas when they are undervalued, leads to better alpha generation.

Similarly for much of past two years, equity investors chased momentum on Dalal Street, which resulted in a skewed growth of the market till it all came crashing down when the coronavirus endemic broke out.

And as investors pondered over the next best strategy to grow wealth, value investors were the first to rejoice.

Value-oriented mutual funds have made a strong comeback amid the ongoing uncertainty in the market. After falling up to 38 per cent in last 12 months, NAVs of top value funds have climbed 8-14 per cent in the first 14 days of this month.

The BSE Sensex Total Return Index gained 7.48 per cent during this period.

Down in the dumps even a few days ago, fund managers' conviction in value stocks has paid off with top schemes gaining as much as 11-15 per cent in just a fortnight. With the stock markets correcting by 40 per cent from their highs on global coronavirus outbreak, quality businesses were mispriced as panic set in. This is where value funds come in, with their mandate to spot hidden potential in beaten-down stocks of otherwise in phoenix stocks.

Soon after, as the realisation dawned on market, that the sharp decline has been unfair on companies that have braved business cycles and are now available at inexpensive valuations on a historical basis, it was time for great re-adjustment to begin. Naturally, gains have been greater for value funds who took positions in stocks earlier than others.

The true hallmark of value investing is in preparing for the next up-cycle by adhering to valuation hygiene, waiting patiently for an investment opportunity and capitalising on it in a judicious manner as and when it arrives.

As the domestic equity indices tanked over 30 per cent from their all-time high levels on the fear of the pandemic, quality businesses witnessed heavy panic selling. Market veterans now expect that quality value stocks to recover smartly from these levels which will again benefit the value investor.

The value oriented funds category has 8 key schemes managing over Rs 43,000 crore as on March-2020. One such top ranking scheme is ICICI Prudential Value Discovery Fund , the largest fund (AUM – Rs. 13,900 crore) in this niche thematic category, is number one fund across 7-, 14-days, 1-month, 3-month and 6-month performance.

Muthukrishnan L. is an independent financial adviser.

The opinions expressed in this article are those of the author's and do not purport to reflect the opinions or views of THE WEEK.