The Best Value Funds For 2018 — Don’t Rely On Mutual Fund Categorisation


Beauty lies in the eyes of the beholder”, is a profound quote by Greece philosopher Plato.

Value investing follows this principle. But mutual funds seem to be taking advantage of this. How? We’ll delve more on this later. First, let’s get a better understanding of value investing.

Value investors don’t fall for the outwardly pomp and show of certain companies. They look for the intrinsic value or the ‘inner beauty’ of a stock.

Thus, when other investors lose interest in a stock, value investors bring out the magnifying glass to look for green shoots of the business that may not be visible to others.

The green shoots are expected to grow bigger with time and reward investors substantially. The early adopters or value pickers are the ones who gain the most. 

It is not an easy task for those investors who venture out to find value. Not all green shoots will bear fruit. Some may just be an aberration and wither away. Some require a lot of patience and may deliver a bountiful produce several years down the line. Hence, value investing requires sound financial knowledge, an observant eye, and patience.

This is certainly not an easy job for most retail investors like us. But don’t worry; you can pick mutual funds where the fund manager has adopted a value style of investing.

Fund managers adopt different approaches to value investing.

Just because a stock falls substantially in price, it doesn’t directly imply that a value fund manager would go ahead and buy the stock. They need to discover value by delving deeper into the fundamentals and the business model of the company. This enables the fund manager to estimate the intrinsic value and know the true potential of the stock.

There are different methods to gauge the value of a stock. But the commonly used valuation measure is ratios such as Price-to-Earnings ratio (P/E), Price-to-Book Value (P/BV), and dividend yield ratio. A fund manager may use these quantitative ratios or a combination of these, along with other parameters to screen value stocks.

As mentioned earlier, value investing requires tremendous patience. A good stock may remain undervalued for years, without any positive price movement. However, when the broad market identifies the potential of these stocks, the returns can be overwhelming. Therefore, when investing in value funds, you should have a long-term investment horizon of at least 5-7 years.

Value funds should form a part of your portfolio, if you're seeking decent returns with a lower volatility as compared to mid- and small-cap funds. Then again, you might have to stomach high risk.

Value funds usually do arrest the downside in a bear market, and reasonably outperform in a bull market. Therefore, such market corrections are a good opportunity to start investing in these funds. Before investing in any mutual fund, it is imperative that you consider the long-term track record and analyse the potential of the funds to generate higher risk-adjusted returns.

How do you identify value-style funds?


Well, the regulator has clearly defined the different categories of mutual funds. But they have only added to your confusion.

They have classified Value Funds as a separate category where the scheme should ‘follow a value investment strategy’ with a minimum of 65% exposure to equity assets.Seems like you need not look any further right? Wrong!

Other categories of funds too may adopt an undercover value investing approach.

Fund houses also have the option to launch Contra Funds. These funds adopt a contrarian style of investing and are an alternative provided by the regulator to Value Funds. This means, a fund house can have either a Value Fund or Contra Fund, but not both.

The difference: Contrarian investing and value investing both rely on the inherent value of a business. However, a contrarian approach seeks to go against the herd—buying good stocks when everyone else is selling. A pure value approach may look to identify undiscovered growth potential (because of products in pipeline or new commercial opportunities, etc.) of a business irrespective how the stock is trending.

If you think you can limit your search until there— wrong again. There is also a category of Dividend Yield Funds. Such funds are expected to invest in dividend yielding stocks. Picking stocks with a high dividend yield is also a form of value investing.

But as fund houses launched schemes with varied investment objectives in the hunt for assets, they seem to have lobbied with the regulator to keep Dividend Yield Funds as a separate category.

While all the above three categories revolve around the value investment style, it is important to note that even market-cap oriented funds can follow a value style of investing.

For example, a Large Cap Fund has an objective to invest 80% or more in the top 100 companies by market-cap. Now, these stocks can be selected using a strategy that is the forte of the fund manager. Thus a fund manager, who believes strongly in value investing principles, may adopt the value style approach. Others may follow a Growth-style or Blended-style of investing.

Those of you familiar with Parag Parikh Long Term Equity Fund would be aware that the founder late Mr Parag Parikh was an ardent believer in the value style of investing. In fact, the scheme was earlier known as Parag Parikh Long Term Value Fund. However, post the regulators diktat, the scheme was reclassified as a multi-cap fund and renamed to exclude ‘Value’ from its name. Does this mean the fund manager will not adopt a value style of investing?

Are Value Funds Hogwash?


This brings us back to the first line of the article – “Beauty lies in the eyes of the beholder”

So, whether a stock is a value pick or not, lies in the rationale of the fund manager. But they don’t need to disclose their logic.

There is no thumb rule for identifying value stocks. It is left at the sole discretion of the fund manager. Thus, a Value Fund may have a whole lot of common stocks in their portfolio, which may not seem like value stocks to others. Who is to judge?

HDFC Capital Builder Fund, categorised under the Value Fund Category, has HDFC Bank, ITC, and Yes Bank as its top three holdings, with a total exposure of 18%. HDFC Bank is present in the portfolio of 105 equity-diversified funds, while the other two stocks are present in the portfolio of over 50 other schemes. Are these value picks?

Similarly, the holdings of JM Value Fund include - HDFC Bank, Yes Bank, Bajaj Finance, Larsen & Toubro, and GAIL (India). These five stocks account for 40% of the total portfolio. The names of the stocks itself give an indication that they may not provide any hidden value, as over 50 schemes already invest in them. But the fund management may think otherwise.

These are just some value funds. Let’s not get started on the portfolio of certain contra funds. If you take a simple glance, you will understand what we mean.

Take a look at the portfolio of Kotak India EQ Contra Fund, and you will see the index heavyweights—HDFC Bank, Reliance Industries and Maruti Suzuki in the portfolio with a total weightage of nearly 20%. Hence, you need to choose carefully.

Are These The Top Value Funds For 2018?

Scheme Name 3 Years (%)
Tata Equity P/E Fund 15.06
Invesco India Contra Fund 13.50
Aditya Birla SL Pure Value Fund 13.38
IDFC Sterling Value Fund 13.08
Principal Dividend Yield Fund 12.96
HDFC Capital Builder Value Fund 12.50
L&T India Value Fund 12.48
JM Value Fund 11.93
Kotak India EQ Contra Fund 11.28
ICICI Pru Dividend Yield Equity Fund 10.93
Quantum Long Term Equity Value Fund 10.34
Templeton India Value Fund 10.29
Reliance Value Fund 9.37
UTI Dividend Yield Fund 8.63
ICICI Pru Value Discovery Fund 7.34
SBI Contra Fund 7.16
UTI Value Opp Fund 7.10
Aditya Birla SL Dividend Yield Fund 5.12
Category: Benchmark
NIFTY 500 - TRI 10.69
S&P BSE 200 - TRI 10.57
S&P BSE Sensex - TRI 9.62
Data as on July 5, 2018
(Source: PersonalFN Research, ACE MF)

Don’t just chase performance. Take a deeper look at how a Value Fund or Contra Fund or Dividend Yield fund is managed. Are they staying true to their principles? If not, it would be better to opt for an equity-diversified fund.

To conclude…

You need to carefully analyse how Value Funds are picking stocks. Are they offering you something different or are they just repackaging a closet indexing approach as a value style portfolio? Such funds may do well in certain periods, but be wary before considering them for your long-term investments.

As far as investing in value oriented funds is concerned, certainly there are merits.  However, managing a value fund is not cake walk. 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. Clearly, not all fund managers may be bold enough.

Hence, careful selection matters a lot to have the best mutual funds schemes in the portfolio. Sound risk management strategies are of the utmost importance for a fund house offering value style funds.

Value funds are suitable for investors with a moderate-to-high risk profile and whose investment horizon is at least five years. PersonalFN is of the view that investors may consider adding well-managed value funds to their portfolios, especially the ones with established track records. 

At PersonalFN, we follow a rigorous research process to help you, investors, select the best mutual fund schemes for your investment portfolio. 

If you already hold a mutual fund portfolio, timely reviewing the portfolio is highly recommended. PersonalFN can help you with that and offer you advice on how to align your investments with your retirement needs.

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Author: Jason Monteiro


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