Value funds are those mutual funds that tend to focus on safety rather than growth, and often choose investments providing dividends as well as capital appreciation. They invest in companies that the market has overlooked, and stocks that have fallen out of favour with mainstream investors, either due to changing investor preferences, a poor quarterly earnings report, or hard times in a particular industry.
Investing in value fund involves identifying fundamentally sound stocks that are trading at a discount to their fair value. The fund manager buys these stocks and holds them until the stock bounce backs to its fair value. The fund managers identify undervalued stocks in the market on the basis of fundamental analysis techniques. In this process stocks with low price to earnings ratios are tagged. These stocks are then closely reviewed to see which ones have the greatest growth potential and are paying high dividends.
Negatives of Value Funds
Though value funds are perceived as safe investments, since they have low volatility and are long-term investments, in reality it may not be so. These undervalued stocks can trade at discounted prices for an extended period of time, thereby reducing the amount of return relative to the risk associated with the investment.
Suitability of Value Funds
Value style of investing works particularly well during a bear phase in the stock markets. During this time, 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. Thus value funds are particularly suitable for investors with a moderate risk profile. As value funds react slowly to market movements, they can be a good instrument of investment for those investors who are due to retire shortly.