Exploring Contra Funds & Contrarian Investing Strategy

6 mins read
by Angel One

Mutual fund managers adopt several strategies to earn excellent returns for investors, one of these is contra funds. Contra mutual funds invest against the ongoing market trend and choose unpopular stocks. This article explores contra mutual funds and some essential factors that you need to know before investing in these funds.

What are contra funds?

The term contra is the short form of contrarian. It derived its name from the investment philosophy it follows.

In its categorisation of mutual funds, SEBI has clubbed value and contra funds together, meaning the fund management companies can invest either in value funds or contra funds and not in both.

Contra funds believe in the philosophy of investing against market trends in stocks and sectors which investors overlook. In a word, these funds invest against ongoing market trends. If you like a little adventure as an investor, you need to know about contrarian funds.

While the risks are high, this investing style also allows investors to earn higher returns. The fund managers take a contrarian view of the stocks when investors reject them. And so, they try to capitalise on the distorted value of the asset. The core belief is that any exorbitant price will normalise in the long run once the triggers subside.

Fund managers of contra funds buy stocks in companies at a lower price than their long-term value. There can be times when specific sectors and businesses slump due to prevailing market conditions. The contra funds invest in such stocks and hold them till their values recover. It is important to note that these funds tend to perform well in the long run since they try to ride over the business cycles. Investors with short-term investment goals may avoid investing in contra funds.

The fund managers keep a close watch on the market to identify the underperforming stocks with a potential to rise in the future.

Characteristics of contra funds

  • Contra funds invest in undervalued stocks with a potential to grow in the future
  • Funds managers select stocks from companies that are currently underperforming
  • Blue-chip company firms hardly make in the portfolio of contrafunds

Who should invest?

If you are a risk-averse investor, contra funds are not suitable for your portfolio. Investors of these funds are aggressive ones, willing to take higher levels of risks for higher returns. While investing in contra funds, you should have a long investment horizon so that you can avoid market volatility risks to an extent.

Secondly, contra funds don’t fit into a short-term investment horizon, significantly less than five years. It is because contra funds apply the value investment strategy, which picks undervalued stocks that will generate returns in the long run. Hence, they don’t generate returns in a short time. Moreover, companies take some time to come out of a slump caused by the negative news around their businesses.

Advantages of contra funds

Contrafunds are for long-term investments. Because of the investing strategy followed by these funds, they generate superlative returns over an extended investment horizon. If you want to invest in contra funds, you must know about the benefits of it.

  • Contra funds invest following the value investment philosophy where fund managers identify undervalued stocks with solid fundamentals. It allows investors to realise massive profit as stock prices grow in the long run.
  • During a bull run, stocks in a contra fund portfolio can generate benchmark beating returns.
  • Investing in these funds allows investors to build an effective hedge against a market correction.

Risks of investing in contra funds

Contra funds investing have the following risks.

  • Contra funds usually take longer to turn around, and sometimes, they may even fail to do so.
  • If the stocks never recover, the fund manager may decide to exit and accept losses. In that case, investors will suffer huge loss too.

Things to consider

Contra funds distinguish themselves from other mutual funds by their investing style. It follows the philosophy of value investing. We always suggest that investors look at the past performance of a fund before investing. They also need to consider the following before investing in contra mutual funds.

Investment horizon

Stock under contra funds take a long time to realise a profit. Hence, you must plan to remain invested for at least five years for excellent returns.

Market performance is irrelevant

Contra funds invest against market trends. Hence the market performance is unimportant. Returns from these funds depend on the individual performance of the stocks in the portfolio, meaning you can earn returns when the overall market isn’t doing well or book losses when the market is at an all-time high.

Risk profile

Since contra funds invest in undervalued stocks, they carry higher market risks. Hence, appeal more to aggressive investors. These funds are suitable for investors aware of macro trends and prefer to take selective bets for higher profit. Unlike other equity mutual funds, contrafunds invest following value investing strategy, and hence, investors of these funds should be ready for the possibility of moderate to high losses even when overall market performance is better since these funds invest in underperforming stocks and sectors.

Fund managers and research

The fund’s performance depends heavily on the judgement of the fund manager. The fund manager is responsible for selecting stocks for investing. Hence, as an investor, you must research the fund manager’s performance before investing.

Best performing contra funds in FY 21-22

Contra funds take a slightly different approach while investing. It involves selecting stocks that are currently underperforming or witnessing a slump. One must note that there is a slight difference between value investing and contrarian investing style. Fund managers of value funds will select stocks currently trading at a value lower than their intrinsic value. These stocks usually have solid fundamentals and the potential to grow in the future.

Contrary to this, contra fund managers select stocks that have fallen out of favour of investors under current market conditions. The investing approach can lead to significant rewards if the fund manager chooses the right assets. Based on the current performance track, some of the contra funds have performed better than others. We have listed their names below. However, if you plan to invest in these funds, do your research before selecting.

SBI Contra Fund

In recent times, SBI Contra Fund has performed well and generated good returns for investors. It was launched on May 6, 2005, and is a moderately high-risk fund.

SBI Contra Fund has given 16.4% returns in annualized CAGR since inception. During 2020, 2019, and 2018, the fund had generated returns respectively 30.6%, -1%, and -14.3%. It ranks 48 in the contra fund category with an AUM of Rs 2973.61 crore.

Kotak India EQ COntra Fund

The Kotak India EQ Contra Fund is another moderately high-risk fund, which started on July 27, 2005. It has given returns at an annualized CAGR of 14.1% since it was launched. As of September 2021, AUM under the fund was Rs 1,169 crore.

Invesco India Contra Fund

The fund’s proposal mentions that the fund’s objective is to generate capital appreciation for investors through investment in equity and equity-related instruments adopting a contrarian approach. The moderately high-risk fund had given a CAGR of 15.3% since its launch on April 11, 2007.

Taxation on contra funds

Returns received on contra funds are taxed like other equity funds depending on the holding period. For an investment duration of less than one year, short-term capital gain tax applies at a rate of 15%, irrespective of the investor’s income tax slab. In case of long-term capital gain tax, up to Rs 1 lakh is made tax-free. Any capital gain exceeding Rs 1 lakh is subject to long-term capital gain tax at the rate of 15% without any benefit of indexation.

In a nutshell

Contra funds are particular types of equity-linked mutual funds designed to generate higher returns from equity investment. These funds don’t chase the market trend. Because of their investment policy, these funds are suitable for aggressive investors with a vast knowledge of macro market trends. One must keep in mind these funds may not perform in the short run. Hence, patience is essential, and investors with long-term investment goals should only invest in these funds.

Contra funds allow investors to diversify their portfolios, and one can invest 10, 25, or 35% of their investable corpus in these funds depending on their investment outlook. However, these funds shouldn’t be dominant in your portfolio. Compared to contra funds, growth funds generate more returns for investors. If you must invest in contra funds, do your research and select funds that align with your overall financial goals.

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What are contra funds?

Contra funds invest following contrarian investment strategy, which picks underperforming stocks and sectors following the business cycle. These funds are high-risk during short runs. Hence, investors must have a long-term investment view while investing in contra funds.

Are contra funds good?

Contra funds can generate market-beating returns but also carry high investment risks. Investors should be aware that they can incur significant losses from investing in contra funds. Hence, these funds are suitable for aggressive and experienced investors with a long-term investment horizon.

Which is the best contra fund?

We suggest that you research the market before selecting. Before you pick a fund, consider its past performance and the track record of the fund manager.