As we all know, there are various types of mutual funds catering to different investment needs. And having the right mix of mutual funds in your portfolio may aid in building a corpus over a period of time. Likewise, investing in value funds would lead to diversification in investment style and unlock the potential of wealth creation over the medium to long run.
What is a value fund?
It is a variant of an equity mutual fund that invests predominantly in stocks that are available at an undervalued price but have the potential for an up move.
The fund managers of value funds aim to identify and invest in stocks that are deemed to be undervalued in the price for various reasons that are trading below their actual worth but exhibit their ability to grow. Once the market realizes the stock’s true value, the stock price increases. And, the fund thus stands to gain from this price rise.
The fund managers may consider one or more valuation metrics viz., price to earnings ratio, price to book ratio, discounted cash flow, earnings yield, free cash flow yields etc., to determine the intrinsic value of a company. There are also various other qualitative factors considered while determining the intrinsic value of a company, which includes business model, competitive position, management team, etc. If the company’s market value is less than its intrinsic value, then it is considered to have ‘value’. These stocks are deemed to be undervalued and have future growth potentials. The fund enjoys the flexibility to invest in stocks across the market capitalization and sectors.
What makes value funds worthwhile?
As understood a value fund is a fund that follows a value investing strategy and seeks to invest in stocks that are deemed to be undervalued in price based on fundamental characteristics. The premise behind value investing is that the market has some inherent inefficiencies causing specific companies to trade at levels below their actual worth for various reasons. Value fund managers are skilled in identifying these market inefficiencies, thus gaining from the expected increase in the share price.
In contrast to value investing, growth investing focuses on companies with high growth prospects whose earnings are expected to increase at an above-average rate compared to their industry or sector or the overall market.
Investors may consider investing in both Value and Growth funds with an objective to achieve diversification to the overall equity portfolio and benefit from growth potential over the long period. The percentage of allocation to each of these funds would depend on market conditions along with the individual’s ability and preference for risk.
What is the tax treatment?
Mutual fund receipts comprise income distribution and/or capital gains at the time of redemption. Hence, there are two perspectives involved in tax treatment. Investors are given to choose between the options i.e., Growth and Income Distribution cum Capital Withdrawal Plan at the time of the application
Effective, FY 20-21 Dividend Distribution Tax (DDT) has been abolished. However, income received from Mutual Funds is now taxed at one’s marginal tax slab. Such income distributed by the mutual funds is also within the scope of Tax Deducted at Source (TDS). As per the latest tax reforms, TDS is deductible where income distribution proceeds exceed Rs 5,000 in a year at a rate of 10%.
The difference between the redemption value and acquisition cost is the gain that you make. The holding period determines the nature of these gains. Where the investment in an equity fund is held up to 12 months, the gains on redemption are short-term capital gains. In other cases, where the holding period exceeds 12 months, it results in long-term capital gains. Short-term capital gains are subject to a 15% tax. Whereas, long term gains up to Rs 1 lakh realised in a financial year is exempt from taxes and capital gains above Rs 1 Lakh are taxable at 10% (plus applicable surcharge and cess, if any).
What is the ideal time horizon?
A value fund is a suitable option for investors having a medium to long-term time horizon. It is preferable to stay invested for at least 5 years. A Systematic Investment Plan (SIP)* can help in tackling market volatility over time and would create a disciplined approach to investing.
(*SIP is a process for a disciplined investment of a certain amount on a pre-decided date in a specific mutual fund scheme, regularly over a period of time.)
Who should invest in value funds?
Value funds are suitable for investors looking for diversification in investment style over growth funds. Investors may also consider investing in value funds to build one’s core portfolio holding and looking for achieving long-term goals.
Disclaimer– An Investor Education Initiative by UTI Mutual Fund.
Mutual Fund investments are subject to market risks, read all scheme related documents carefully.
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