Investing in mutual funds offers a wide array of options to cater to diverse financial goals and risk appetites. Among these, contra funds stand out for their contrarian investment strategy. These funds adopt an approach that goes against prevailing market sentiments, making them a compelling option for investors willing to take calculated risks for potentially high rewards. This article delves into the concept of contra funds, how they work, their benefits and risks, with few examples of different types of contra funds and their performance over the period.

Contra funds operate on the principle of contrarian investing, which involves identifying and investing in stocks that are currently out of favor in the market but are expected to perform well over the long term. The portfolios of contra funds have defensive and beaten down stocks that have given negative returns during the bear market. The idea is to purchase fundamentally strong companies which are currently undervalued or sectors that have strong fundamentals but are overlooked due to temporary market trends or negative sentiments as the core belief is that any excessively high value of asset will eventually normalize in the long term once the existing triggers are mitigated. This approach requires patience and a long-term perspective, as these funds tend to perform better over the long term and are not ideal for short term investments.

Let’s understand this with an example,

During Covid, hospitality stocks didn’t do well for obvious reasons. There were lockdowns, and people were not traveling. Contrarian investors would have looked at the valuations of such stocks and bought some that were available cheaply.

The idea behind contra funds is that the market often overreacts to short-term events, leading to mispricing of certain stocks. By investing in these undervalued assets, contra funds aim to generate substantial returns when the market corrects itself and these stocks gain value.. So, during the recession phase, already having a contra fund in your portfolio basket might act as a cushion to the damage in your portfolio as it will take care of the mighty corrections due to its principal of contrarian investing. While the risks are high, this style of investing offers investors an opportunity to earn superlative returns.

Benefits of Investing in Contra Funds:

• Potential for High Returns: By investing in undervalued stocks, contra funds have the potential to deliver high returns when the market realizes the true value of these stocks.

• Diversification: These funds often invest in a broad range of sectors and stocks, providing diversification to an investor’s portfolio.

• Opportunity to Beat Market Trends: Contra funds offer investors the chance to capitalize on market inefficiencies and take advantage of overlooked opportunities.

• Professional Management: The fund is managed by experienced professionals who have the expertise to identify undervalued opportunities and navigate market fluctuations.

Risks Associated with Contra Funds:

• Long-Term Commitment: Since contra funds focus on undervalued stocks, it may take years for these investments to yield substantial returns. Investors need patience and a long-term perspective.

• Higher Risk: The contrarian approach involves investing in stocks that are currently out of favour, which inherently carries higher risks compared to traditional equity funds.

• Market Dependency: The success of contra funds largely depends on the market’s ability to correct mispriced stocks over time.

• Potential Underperformance: In a bull market where trending stocks dominate, contra funds may underperform compared to other equity funds.

As per the SEBI guidelines on Scheme categorization of mutual funds, a fund house can either offer a Contra fund or a value fund, not both. Different Contra Fund schemes currently are as follows:

• SBI Contra Growth Plan

• Invesco India Contra fund

• Kotak India EQ Contra Fund

How these Contra Funds have performed:

Now, let’s have a discussion on the Funds in the category and their performance over the period.

If we look at the trailing returns of the fund, then the SBI Contra fund has outperformed its benchmark and peers in all time frame especially when we look for a larger time horizon.

The table below represents the trailing returns of the funds, index and its category as on December 2024.

Investors look to invest a part of their portfolio in contra funds when the market is at an all-time high and everything seems overvalued. 

While the returns earned by contra funds can be very high, the risks are equally high. The minimum suggested investment period for contra funds is three to five years because it takes time for undervalued stocks to recover their value and for contra funds to generate significant returns. Industry body Association of Mutual Funds in India (AMFI) has cautioned that contra funds carry the risk of getting calls wrong as catching a trend before the herd is not possible in every market cycle and these funds might underperform in a bull market. 

Conclusion:

Contra funds are suitable for investors who have a high-risk tolerance and are willing to invest for long term (5-7 years or more). In a dynamic investment landscape, contra funds offer a unique opportunity to tap into undervalued stocks with promising growth potential. For those willing to adopt a long-term perspective and embrace the principles of contrarian investing, this fund could be a valuable addition to their portfolio. However, investors should always assess their financial goals and risk tolerance before investing in this fund.

To understand more on the topic as well as to start investments please feel free to contact us:

Phone: +91-9324609115

E-mail: team@richvikwealth.in

The article is authored by Mr. Vishal Gangaramani from Team RichVik.