Value Funds vs Growth Funds: Which Is Better in Volatile Market?

Jun 08, 2022

Listen to Value Funds vs Growth Funds: Which Is Better in Volatile Market?

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The Indian equity market has been on a roller coaster ride for some time now and has corrected itself from the stellar run recorded in October 2021. As a result of enormous inflation and an unanticipated war crisis, the market pendulum began to swing back in December 2021. Experts anticipate that the markets will experience increased volatility throughout the year as a result of the geopolitical tensions between Russia and Ukraine and their implications.

The volatility has escalated in the Indian markets both S&P BSE Sensex and Nifty 50 are fluctuating dramatically over the last few weeks and have corrected from their all-time highs. At this level of volatility, you might be wondering whether to invest or wait for the market to stabilise. However, it is the inherent nature of stock markets to be volatile. Higher volatility offers investors a chance to gain a higher return because every dip provides an opportunity to invest.

Market corrections, according to experts, should be viewed as windows of opportunity. Historically, whenever the market has seen a significant correction, the indices have bounced back to their previous levels or even higher in the period immediately after the correction. On the other hand, market volatility is an unavoidable part of equities investment, and there is a considerable risk of losing money if an investor lacks the capacity to absorb a notional loss, which is usually short-term in nature.

Due to market volatility induced by many macroeconomic challenges, rising interest rates, and inflation, mutual fund investors are looking for low risk bets. When it comes to mutual funds, investors can choose from a variety of options such as active vs. passive, debt vs. equity, and growth vs. value investing based on their risk profile and investment objectives.

Since the market never moves in a straight line, investors have to deploy different strategies such as value investing and growth investing for generating significant returns on investments. When selecting stocks for a mutual fund scheme, fund managers normally follow a certain approach. This investing approach can either be growth or value based.

Growth stocks are the stocks of companies that grow at a faster pace and have the potential to outpace its peers and the category average in the long run. However, a quick decline in a stock price owing to negative earnings or unfavourable news about a firm is always a risk. Value stocks are those that are trading at a price lower than the intrinsic value derived based on company's fundamentals, such as dividends, earnings, or sales, etc. The goal of value investing is to buy a stock while it is undervalued or on sale, and then sell it when it reaches or exceeds its true or intrinsic value.

Value Funds vs Growth Funds: Which Is Better in Volatile Market?
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Although both value and growth funds are great investments, it is important to understand each one of them in terms of the risks involved, yields, and even the holding period it requires to generate significant returns.

What are Growth Funds?

A Growth Mutual Fund is one that invests in growth stocks (of emerging companies) in order to maximise capital appreciation. A growth fund's portfolio is made up of companies that are making rapid progress and can provide investors with higher returns.

In undergrowth investing, the money put in by investors is constantly reinvested in the stock market for gains. Due to this, the NAV of a growth fund is usually high when the stocks are gaining, and it could go down when the stocks are losing in the market. Growth Funds have a moderate-to-high risk profile and invest in companies that are experiencing rapid growth. This is why Growth Funds look for businesses that have a track record of rapid revenue growth or that are younger and have potential. On the flip side, the risk is also on the higher side. Growth Funds are classified as large-cap, small-cap, mid-cap, diversified equity funds, etc.

Growth stocks are also known as momentum stocks because of their strong upward trend, which attracts an increasing number of investors. Growth Funds may impact investors when the market falls sharply, just as they can reap significant capital gains when the market is favourable.

What are Value Funds?

Value Mutual Funds are a kind of equity mutual fund where the stocks are generally considered undervalued but have a higher dividend yield. These stocks may not be performing well in the market currently, but fund managers believe they have growth potential and consider investing in them.

Value investing is based on the premise that paying less for a set of future cash flows leads to a higher expected return. These value fund investors are often buying stocks that are now out of favour and hence have a low valuation. They're hoping that the market's sentiment will shift in their favour, causing the stock price to rise. While Value Funds may underperform in a market that is driven by momentum or polarisation, they excel when the market rally is broad-based and driven by fundamentals and earnings upgrades.

Growth and Value investment styles are among the most commonly used investment strategies, and there are significant differences between the two. The age-old debate among investors is whether Growth or Value Funds are superior.

The growth investment strategy focuses on identifying companies that can outperform their competitors in terms of sales and profit growth. As a result, growth stocks have the potential to see a significant increase in stock values over time.

On the other hand, value investing is concerned with identifying and investing in companies whose stock prices are below their intrinsic value. This technique focuses on investing in undervalued stocks that have the potential to produce high returns as stock prices approach their real value.

Here's what you need to know before choosing a Growth or Value Mutual Fund, starting with a review of the major differences:

Parameters Growth funds Value funds
Company features The companies in a growth fund portfolio register higher earnings and market growth. The companies in a value fund portfolio are likely to show lower sales and earnings but give out higher dividends.
Market growth Focused on the higher market growth for long term capital gain Focused on substantial growth with higher dividend pay-out.
Holding period Short term to long term Long term
Returns Higher returns as your money are regularly reinvested back into the fund itself Returns are distributed in the form of dividend
Risk Growth funds carry high risk due to the volatile nature of equities. Value funds are less risky in comparison to growth funds
P/E Ratio The P/E Ratio of growth stocks tends to be higher than the P/E Ratio of value stocks. Generally, a low P/E Ratio
Bets returns on Projected future profitability Market psychology
Suitable for Ideal for investors with a long term investment approach Ideal for investors seeking regular income
 

Note: Taxation in India is the same on both Value and Growth Funds, depending on whether they are equity-oriented or debt-oriented.

Equity funds are tax-free on long-term capital gains (LTCG) below Rs 1 lac, whereas more than 1 lac is taxable at 10%. Debt funds LTCG gains are taxed at 20% with indexation and 10% without indexation. While Short-term capital gains (STCG) for equity funds are taxed at 15%, for debt funds, the gains are added to an individual's income and taxed as per their income tax slab.

Should investors consider Value Funds or Growth Funds amidst the market volatility?

 

The market goes through cycles of varying lengths that favour either growth or value strategies. The question of which investing style is better depends on many factors since each style can perform better in different market phases. When interest rates are low and projected to stay low, growth stocks may perform well, but when rates rise, many investors will shift to value stocks. Growth stocks have recently outperformed value stocks during the market rally, but value stocks have a strong long-term track record.

Both Growth Funds and Value Funds have their pros and cons. However, neither of these options is perfect, and investors should weigh all of the aforementioned factors before deciding on one of them. What is a preferable way to proceed for investors? Well, one approach is to invest equally in both growth and value strategies. Together, they add diversity to the equity side of a portfolio, offering the potential for returns when either of the investing styles is in favour.

Since it is not possible to time the market, it is advisable to invest in a mix of growth and value style funds based on your financial goals and risk profile. This will assist you in obtaining favourable returns during various market phases and cycles. However, you should avoid investing in either Value or Growth Funds based on previous performance only.

As a result, in order to balance the risks, an optimal investment portfolio should include both Value and Growth Funds. Value Funds add stability to your portfolio, and Growth Funds allow your investment to grow.

Therefore, the decision to invest in Growth vs. Value Mutual Funds ultimately depends on an investor's preference, as well as their risk tolerance, investment goals, and time horizon. It's worth noting that, during shorter time periods, the performance of either Growth or Value Funds will be heavily influenced by the market's stage in the cycle.

PS: If you wish to select actively managed worthy mutual fund schemes with either growth or value stocks, I recommend that you subscribe to PersonalFN's unbiased premium research service, FundSelect.

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Warm Regards,
Mitali Dhoke
Jr. Research Analyst



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