What are Value Funds: Definition, Features and Investment Benefits?

Value funds can be defined as open-ended mutual funds that follow value investment strategy to pick and invest in undervalued equity stocks across market capitalization and sectors. Undervalued equity stocks can be defined as ones that have a market value which is lower than their intrinsic value.

Generally, value stocks have a high dividend yield, a low P/E (price to earnings) ratio and a priced at a discount when compared to their intrinsic value. So, even though the stock is currently available at a discount, it has the potential to grow investor’s wealth in the long term.

You may be wondering what type of investors should ideally invest in value funds. Well, investors who are have a high-risk appetite and are willing to stay invested in the long term can invest in value funds. This way, the investor can benefit from the long-term investment benefits that a Value Fund and its underlying value investing strategies can provide.

Now let’s take a closer look at how Value Funds work. As already mentioned, these funds invest in those companies which are currently undervalued in the market in comparison to their intrinsic value, as we have already mentioned.

It means that the market price of these shares is lower than their intrinsic value. This refers to their unrealised value based on key criteria such as the company’s current assets, earning potential and cash flow.

Value investors try to identify such company stocks that is seemingly out of favour with most current investors. Based on the belief that their prices will increase over time, value investors buy undervalued stocks at a discount whenever they get the opportunity.

So, the portfolio of this type of mutual fund comprises stocks selected based on certain criteria such as low P/E ratio, low P/B (price-to-book) and/or high dividend yield. To have a better understanding of undervaluation, other metrics like quality of management, performance in current sector, peer comparison etc. should also be checked by prospective value investors.

It’s the responsibility of a value fund manager to choose the right stocks and create a well-diversified portfolio. Their main aim is to hold value stocks for a long time. This provides enough time for the market to recognise the true value of these stocks, that can result in potentially high future profits.

Here are the features and benefits of value mutual funds:

Value funds invest a minimum of 65% of their portfolio in equity stocks which is why as per current rules for taxation of mutual funds, they are categorised as equity schemes. As a result, they follow the taxation rules of equity mutual funds.

You'll realise short-term capital gains (STCGs) if you redeem your value fund investments within one year of investment. These gains will be taxed at a flat rate of 15% of gains, irrespective of the total gains you make from the redemption.

Suppose you sell off your value fund units after a holding period of one year, you'll realise long-term capital gains (LTCGs). These are tax-exempt up to ₹1 lakh in a year. Once the capital gains exceed this threshold amount, it will be taxed at the rate of 10% with no indexation benefit.