What are Value Funds?

Published On: 07-Aug-2020

When investing in equity markets, investors may adopt various investment strategies to pick the stocks. Such investment strategies may be broadly classified into growth investing, value investing, and contrarian investing. While growth investing chases high-growth shares often quoting at a premium, value investing aims for highly discounted valuations for stock picking. 

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Contrarian investing refers to investing against the market direction based on deep conviction into the specific stocks/ companies. For retail investors, it may be challenging to cherry-pick stocks quoting at less than their intrinsic valuations, for it requires in-depth research and fundamental analysis of the company. Value Funds come to the rescue of such investors, who are aiming to adopt a value investing approach in their financial plans.  

What are Value Funds?

A value fund is that fund that adopts value investment strategy and has invested at least 65% of its net assets in equities and equity-related securities. Warren Buffett has been one of the prominent value investors, falling in the footsteps of Benjamin Graham. He once said, “price is what you pay; value is what you get.” This quote acknowledges that price and value may not be the same, even in an open market. There may be several companies listed on stock exchanges which are fundamentally stronger but are quoting at much lower than their intrinsic valuations. 

The stocks may be underpriced due to prevailing market conditions or some stock-specific short term concerns. Such deeply discounted valuations also provide a favorable risk-reward tradeoff to the investors with a fair margin of safety and a reasonable cushion for stock appreciation. When one aims to pick stocks that are trading at deeply discounted valuations against the company fundamentals, it is referred to as value investing. 

This category of funds, coupled along with contra funds, carries around 7% share across the AUM (Assets Under Management) across all the open-ended equity funds with an AUM figure of Rs. 0.48 lakh crores (Data as on 30th June 2020)

Source: Association of Mutual Funds in India - AMFI.

Who should invest in Value Funds?

Value funds predominantly rely on core value investing strategy to generate returns for the investors. However, the value stocks may take a reasonably long period to bounce back to their intrinsic valuations. While the value funds may take the responsibility of finding the right stocks and investing at the right value, the investors must also be prepared to stay invested for a reasonable period to fetch the real value of such stocks through value funds. As such, value funds are generally suitable for investors with long term investment horizons. 

Taxation of Value Funds

Since value funds invest at least 65% of its net assets in equities and equity-related instruments, it is classified as equity-oriented mutual funds under tax laws. When one redeems a value fund, the difference between the redemption value and the invested amount is taxed as capital gains. 

If the holding period of the units so redeemed by the investors is less than 12 months, the gains are taxed as Short Term Capital Gains (STCG) at 15% (plus applicable cess and surcharge). For the holding period of 12 months or more, the gains are taxed as Long Term Capital Gains (LTCG) at a rate of 10% (plus applicable cess and surcharge). Further, an aggregate exemption of Rs. 1 lakh per year is also available in respect of LTCG from equity shares and equity-oriented mutual funds in aggregate.

Investors may aim to capitalize on the significant gaps between the stock prices and their intrinsic valuations through value funds. 

Note: The tax provisions, as mentioned in the article, are for illustrative purposes only, and are updated as per the Union Budget 2020 passed by the Parliament. The tax rates for capital gains will be as per the tax laws applicable on the date of redemption/ sale and not on the investment date.