Value funds are equity mutual funds that mainly invest in companies whose stocks are undervalued. The idea is simple. Instead of buying a stock just because it is popular or its price is rising, these schemes look for good businesses that the market may be ignoring or undervaluing.

For example, a company’s share price may fall because of a temporary problem. But if the business itself remains strong, the fund manager may see this as an opportunity to buy the stock at a lower price.

Since a value fund is an equity fund, it must invest 80% of its total assets in stocks. The remaining 20% can be invested in other instruments, such as government or corporate bonds.

Value mutual funds are basically based on the philosophy of value investing. It is the idea of buying good companies when their stocks are available at a price lower than what they may actually be worth.

This is Warren Buffett's investment approach. Value mutual funds follow a similar idea. However, the fund managers make the actual investment decisions based on the fund’s strategy.

Value funds are not meant for investors looking for quick returns. They can be a suitable option for you if:

• You are a long-term investor: A stock that looks cheap today may take years to recover. You need to be comfortable staying invested for at least 5 years to reap benefits.
• You want to follow a value investing approach: If you already invest in growth schemes like small-cap funds or mid-cap funds, and want to add a different investment style to your portfolio, value funds can be a good choice.
• You don’t want to bet on one sector: Unlike sectoral funds, value funds can find opportunities across banking, pharma, IT, and other industries. Your growth doesn’t depend on one sector.
• You are comfortable with a phase of slow returns: A value fund can underperform for a while before its investments start working out.

When you invest in a value fund, the fund manager buys stocks of undervalued companies. These companies are categorised as undervalued based on their:

• Earnings
• Debt levels
• Cash flows
• Assets
• P/E and P/B rations
• Business prospects, etc

The fund manager decides whether the stock is cheap for a temporary reason or because the business has real problems.

Let’s look at how this plays out in practice. Suppose you invest ₹5,000 in a value fund at an NAV of ₹50. You get 100 units of the scheme.

The fund manager finds a company whose stock price fell recently. After studying, the manager believes its business is worth more than the current market price. The stock has fallen mainly because raw material costs increased. Whenever the costs come down, the company’s profits will improve, and the market may start valuing the company more highly.

Your investment could then look like this:

The important point is that the recovery may take time. The fund does not make money simply because a stock is cheap. The underlying business has to improve, or the market has to recognise its value.

• You can invest in undervalued companies: Value funds look for businesses that may be available at a lower price than their estimated worth.
• You don’t have to find stocks yourself: The fund manager and research team analyse companies and decide which ones to buy. You don’t have to research the company’s valuation.
• You get exposure across sectors: The fund manager has flexibility to look for valuable companies across different industries. This differs from sectoral funds, which focus on only one industry.
• You can benefit if the company improves: If the company's business improves and more investors buy the stock, its valuation can rise with its earnings. This can help the fund earn better returns.

Value funds don’t guarantee higher returns. Here are some risks involved with them:

• Value trap: A stock may be cheap because its business is actually getting worse. High debt, poor management, or products with reducing demand can stop it from recovering.
• Can lag during growth rallies: When most investors are strongly buying fast-growing stocks, value funds may underperform large and mid cap funds or blue-chip funds.
• Economic slowdown: Some value opportunities are found in cyclical industries such as metals, power, cement and banking. A weak economy can delay their recovery.
• Long waiting period: The market may take years to recognise a company’s value. During this time, your investment may deliver low or negative returns.

How can you handle these risks?

By following these simple hacks, you can reduce the risks to some extent:

• Give your investment at least 5 years or more to play out.
• Invest via SIP instead of a lump sum to avoid timing the market and average out your buying price.
• Don’t put all your money in value mutual funds. Consider other schemes such as focused funds or index funds.
• Keep short-term money in a suitable scheme such as ultra-short duration funds, money market funds or overnight funds.

Both these funds look for companies that nobody else is buying and are available at lower values. But there are some important differences between them, such as:

For a better balance of growth and risk, you can combine them with other schemes such as multi-asset allocation funds, equity savings funds or balanced funds.

Cheap does not always mean good, and that applies to value investing as well. Here are a few things you should check to find the best value mutual funds for your needs:

• Look at the long-term performance: Check the last 5 or 7 years of performance rather than focusing on one good year. A good value fund should have performed well across different market conditions.
• Understand the fund’s approach: Every mutual fund house provides a fund factsheet. Check details such as the investment strategy and risk level. Make sure they match your goals and risk appetite.
• Check the holdings: Look at the number of stocks and how the fund’s money is spread across different companies and sectors.
• Check the expense ratio: Annual maintenance costs like the expense ratio reduce your returns over time. You can prefer direct plans over regular plans for lower costs.

The best value funds are not necessarily the ones with the highest returns. The right fund should match your investment style and time horizon.

Once you’ve shortlisted value funds to invest in, starting a SIP on Millions is super easy:

• Install the Millions app on your smartphone.
• Verify your mobile number and open a free account after completing KYC.
• Go to the mutual funds section and select a value fund that meets your requirements.
• Click on SIP and choose a monthly, weekly or daily payment option.
• Enter the investment amount, pick the SIP debit date and authenticate the first payment.

You don’t need a large amount to start. A small SIP can help you invest regularly without trying to time the market. As your portfolio grows, you can also diversify across other categories and asset classes. Debt scheme options such as corporate bond funds, banking PSU funds, or gilt funds can be considered based on your goals and risk tolerance.