Many shopaholics live to buy high-end brands and products during a sale. That's the time when products are available for a discount and after the sale period, the new products are back in stores at a premium.

Similarly, value investing involves identifying fundamentally sound stocks that are trading at a discount to their fair value. But investing in value funds is not as simple and easy as purchasing garments during a sale.

It is noteworthy that; value investing refers to buying stocks whose market value has severely deviated from their fair intrinsic value. Unlike market value, which is readily quoted, intrinsic value is not easily available and has to be estimated by conducting a thorough fundamental analysis. Fundamental analysis includes evaluating the financials of the company with help of various ratios; but for valuations, the important ones are: Price-Book value (P/B), Price-Earnings (P/E), Dividend Yield, Price-to-sales. They are used to screen a company based on the value proposition. Besides, value investing revolves around set of investment principle which are:
 

• Companies should have sound management
• Earning capacity of the companies
• Companies should be capable of generating good returns
• Prudent approach towards debt financing

 

Value style funds by definition pick up stocks for their portfolio that are under-priced and are likely to pay good dividends. While undertaking its stock picking activity, the fund manager may discover value buying opportunities in various market capitalisations – and thus you may find a value fund having exposure to large caps, midcaps, and / or small caps.

Moreover, the fund manager may construe the value in the line of business and the business model of the company that enables it to earn luring returns for its investors. This style of investing works particularly well during a bear phase in the stock markets. This is the time, when the fund manager has more opportunities to invest in stocks trading at a discount to their fair value. By buying low and selling high, value funds take on lower risk than growth funds, which tend to buy high and sell higher. This makes value funds particularly suitable for investors with a moderate risk profile.
 

And have Value Funds been a value proposition for investor?
Thus far, there are 21 mutual fund schemes following the value style of investing, and their performance has been quite exciting. In fact, when compared to other diversified equity funds, they have done a notch better. Moreover, they've successfully created alpha across time frames for investors when compared to the S&P BSE 200 index.
 

Report Card of Value Funds

	6 Months	1 Year	3 Years	5 Years	Std. Dev.	Sharpe Ratio
Category Avg. of Value Funds*	23.37	18.81	27.76	16.61	17.01	0.32
Category Avg. of Diversified Equity Funds**	22.64	17.44	26.19	16.32	16.26	0.31
S&P BSE 200	19.72	16.45	19.46	12.74	15.07	0.23

*Category average of value funds is a simple average of 21 schemes following the value style of investing
**Category average of Diversified equity funds is a simple average of 58 schemes which follow other investment styles
Standard Deviation and Sharpe ratio is calculated over a 3-Yr period. Risk-free rate is assumed to be 7.38%)
(Source: ACE MF, PersonalFN Research)

On the volatility front, although they have exposed to investors to slightly high risk (measured in by the Standard Deviation) vis-à-vis other diversified equity funds, on a risk-adjusted basis value funds have compensated investors for the amount of risk assumed.
 

Performance across Market Cycles

	BEAR PHASE	BULL PHASE	BEAR PHASE	BULL PHASE	BEAR PHASE	BULL PHASE
	08/Jan/08 To 09/Mar/09	09/Mar/09 To 05/Nov/10	05/Nov/10 To 30/Dec/11	30/Dec/11 To 03/Mar/15	03/Mar/15 To 25/Feb/16	25/Feb/16 To 06/Sep/16
Category Avg. of Value Funds*	-53.40	88.07	-24.43	29.25	-19.24	33.87
Category Avg. of Diversified Equity Funds**	-56.00	83.39	-24.93	28.86	-19.21	33.04
S&P BSE 200	-58.97	84.37	-27.04	24.62	-21.08	30.42

(Source: ACE MF, PersonalFN Research)  

The performance across market cycles reveals a fund's ability to generate returns across market cycles. It is clear from the above table that value funds have outperformed benchmark index S&P BSE 200 and Diversified Equity funds during the bull phase. Also Value funds have contained losses during the bear phase of market.

During the bear and bull phases post sub-prime mortgage crisis (2008-09), value funds have performed better on average when compared to diversified equity funds. During the bear phase, they have arrested the downfall, while in the bull phase (post sub-prime mortgage crisis), they accelerated due to better stock picking and margin of safety available during the preceding bear phase.

Even now, while global and Indian equity market is feeling shivers of Brexit, value funds have contained their downfall well as compared to the benchmark. During the ongoing bull phase value funds are generating marginally better returns as compared to diversified equity funds.

Should you invest in Value Funds?
As evident from the performance, value funds have indeed discovered 'value' for investors. They've proven their conviction while constructing the portfolio.

PersonalFN is of the view that, currently the market rally is driven by high optimism and thriving on global liquidity. But, unless corporate profits demonstrate substantial improvement, market valuation would appear expensive. This, therefore, would give chances of a deeper correction until earnings justify valuations.

As far as investing in value oriented funds is concerned, certainly there are merits, because fund managers are yet to discover value bets in different layers of the market capitalisation. Having said this, a careful selection matters a lot to have winning mutual funds schemes in the portfolio. Managing a value fund is not an easy task. It requires the fund house to have a deeper understanding to ascertain whether the investment will be truly valuable or a dud in the long run. It also requires, at times, the courage to go against the market and take bold calls. Therefore, sound risk management strategies are of the utmost importance for a fund house offering value style funds. In our view, investors may consider adding well-managed value funds to their portfolios, especially the ones with established track records.

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