Should you have a value fund in your portfolio?

Summary: Should you own a value fund at all? Read this analysis to see what the data says about their long-term edge, their frustrating dry spells and the role they can play in a diversified portfolio. 

Here’s a question that could stump anyone: Why invest in value funds when you can invest in flexi-cap funds? Both enjoy nearly the same flexibility to pick any stocks across any market-cap segments. That is both get a wide playground to dabble with and both dynamically select stocks based on market conditions. 

This at first blush may suggest that value funds are not much different from a broad-based category. And for this reason, it may not make much sense to keep them in your portfolio. 

But their returns and outperformance history over the broader market suggest a different conclusion. Let’s see how. 

Why value funds are not just another flexi-cap fund

Value funds follow the value style of investing. In simple words, fund managers select stocks they believe are priced below their intrinsic value or actual worth regardless of their size or market category. These could be companies going through a rough patch, sectors that have fallen out of fashion, businesses too boring to attract attention. 

The belief is simple. These stocks are worth more than what they are being traded at, and sooner or later, the market will figure that out. 

This approach makes value funds different from flexi-cap funds in practice, even though both can invest across the market. That difference shows up in the stocks they hold and also in how their returns play out over time.

Where the difference starts to show

An average value fund shares only around 33 per cent of its holdings with the average flexi-cap fund. That is, two out of every three stocks it owns are not found in a typical flexi-cap. 

This means if you keep a value fund in your portfolio, you will get genuine diversification from, say, a broad-based fund like a flexi-cap. And this diversification reflects in their returns too. 

The average value fund has outperformed the Nifty 500 (proxy for the broader market) in nearly 50 per cent of all possible five-year holding periods since 2013. The average flexi-cap fund managed that less than a quarter of the time. 

The value fund also gave a higher average annual return of 15.7 per cent over the flexi-cap’s 14.4 per cent across all five-year periods. The gap widens over holding periods of three years. See table below:

Long-term edge but not a smooth ride

That long-term edge does not mean value funds win all the time. In fact, they can lag for years at a stretch. 

To see this more clearly, we examined every five-year rolling return ending between April 2019 and June 2023, a period when markets were driven strongly by growth and momentum after the pandemic fall. That means each date during this period captures the annual return earned over the previous five years. 

Across all these observations, the average flexi-cap fund returned 10.9 per cent annually, compared with 9.4 per cent for the average value fund. That 1.5 percentage point gap may not look dramatic on paper but over several years it is enough to test an investor’s patience.

This is exactly why value investing is not for everyone. Style leadership never stays fixed. There are phases when cheap, neglected stocks come back into favour and value funds do well. But there are also long periods when investors chase fast growth and strong momentum and in those phases value funds can look dull and disappointing.

That is not a flaw in the category. It is how the strategy works. Value funds are waiting for mispriced businesses to be recognised by the market and that can take far longer than most investors expect.

So should you own a value fund at all?

The five-year rolling data since 2013 shows that the average value fund has done better than the average flexi-cap fund over the long run. But that advantage comes with a condition: you must be willing to sit through possibly long phases of underperformance without losing conviction.

That makes value funds suitable for investors with at least a seven-year horizon and the temperament to watch temporary underperformance without rushing out. 

They are better used as a satellite allocation, not the core of a portfolio. A 10 to 15 per cent share of your equity allocation is usually enough. The core should still come from broader categories such as flexi-cap or multi-cap funds.

If you have decided to add a value fund, the harder question is this: which one? For that, consider exploring Value Research Fund Advisor. Our analysts here assess funds beyond short-term returns, looking at portfolio strategy, consistency, risk and how well a fund can fit into your overall portfolio, so you can choose with greater clarity and conviction.

Try Fund Advisor today