Equity mutual funds fall under many fund types and categories, but the two primary classifications are `growth' and `value'. It is important for investors to know the difference between growth fund and value fund to be able to build an investment strategy and portfolio that suits their objectives.
What are growth funds? What is their investment strategy?
Growth funds buy growth stocks. The companies in the portfolio are expected to grow at a rate faster than the overall stock market. These stocks tend to perform best when the economy is in the mid to late phase of the business cycle and corporate profits are healthy.
Typically, growth stocks have low dividend yields and more than average valuations as measured by price-to-earnings (PE), market capitalization to sales and price to book value ratios (PB), showing the market's high expectations of superior growth. Growth funds can buy both large and mid-cap stocks.
Where does value fund invest in?
A value fund invests in companies which could be underpriced when measured on a fundamental basis. Since a company's share price will not remain undervalued indefinitely, the fund looks to make money by buying before the expected upturn. Value funds tend to focus more on safety rather than growth, and often choose companies that give higher dividend as well as capital appreciation.
The companies they invest in could have low PE ratios, and these stocks could have fallen out of favour with mainstream investors due to poor quarterly earnings, changing investor preferences or tough times for the industry they operate in.
What is the correct strategy?
Many financial planners believe value investing works in mature markets. India has many growth companies, which if invested in can generate alpha. Value funds can be a part of one's portfolio even in a bull market, if one is ready to hold the fund long enough to make up for periods of underperformance.
Investing for long term gives the fund time to discover or unlock the value of the stocks.