Equity or equity based mutual funds can be grouped under several different fund categories and types. However, value and growth are its two main classifications. Investors have to know and understand the difference between value funds and growth funds so as to be able to create an investment plan as well as a portfolio which meets their financial goals and objectives.
What is a growth mutual fund?
Growth funds invest in growth stocks. The portfolio of such funds is made up of companies that are supposed to grow at a faster rate than the general stock market. The stocks of such companies generally perform better than the rest when there are healthy corporate profits and the economy is passing through the mid to late stage of a typical business cycle.
In most cases, growth stocks tend to feature low dividend returns and are valued at more than the average stock pricing when compared against the PE or price to earnings ratio, PB or price to book value, and market capitalization to overall sales, which indicate the high expectations of the markets of superior faster growth by such stocks. Growth fund investments can be in both mid-cap and large cap stocks.
What is a value mutual fund?
Investments of value funds are in stocks which may be undervalued when measured against an elementary basis. The stock price of companies is not going to remain underpriced permanently. Hence, value funds invest in such companies before the speculated upturn and thus expect to make money. The focus of such funds is on safety rather than growth and hence investments are usually in stocks are more likely to offer capital growth and increased dividends.
The stocks that value funds invest in may feature reduced PE ratios and the companies may no longer interest mainstream or big-time investors because of poor or average earnings per quarter, tough periods for the sector or industry of operation, or changed preferences of investors.
Can value stocks become growth stocks?
Value and growth investment ideas are ever changing and not static. After realization of the value in value company stocks, its valuation generally goes up, and thus it ceases to stay a value stock. In a similar manner, when growth company stocks cease or stop growing, then its price drops considerably. It then does not remain a growth stock, but there is a possibility that such stocks may have lots of ‘value’ in them.
It may be however noted that mutual funds usually adhere to their value or growth mandate.
What is the right investment plan?
There are many financial experts and strategists who are of the opinion that mature markets are the best for value investments. There are several growth companies in India and investments in such companies can yield alpha. If investors are ok with holding the fund for a sufficient period of time so as to offset and counter the underperformance periods, then value funds can be added to the portfolio even when the market is on the rise.
A longer investment period allows the fund adequate time to unlock or discover the true value of the shares. Value funds have reduced beta and standard deviation and are thus a good for first-time or conservative investors.
It may however be noted that neither investment strategy offers any guarantees. However, selecting mutual funds that make use of both growth and value styles may allow investors to decrease the risk of substantial loss from any fund during periods of market decline. It is a better option for new investors to go for a large cap blend fund which has stocks of both growth and value companies.