What are contra mutual funds?

Introduction

Contra funds are contrary to the behavior of market trends where fund managers intentionally choose stocks of those companies which were neglected by most of the fund managers in the market. To understand contra funds better, we should first understand the premises of contra investing.

We keep hearing about some companies which are facing difficulties due to their bad fundamentals. These are the companies which attract contra fund managers. They keep their eyes on these types of companies and purchase their stocks at cheaper prices. Their philosophy is simple – purchase stocks at the lowest prices and earn higher profits in longer run once the market settles. Contra funds have the potential to maintain risk-reward balance.

Taking the example of banking sector particularly in the year 2008; the downturn of banking sector in 2008 is well known to everyone. Banking sector was performing poorly, and stocks of financial companies were plummeting continuously. Contra fund managers took this period as an opportunity and bought stocks in banking sector because they knew that Indian banking sector was based on strong fundamentals. The risk reward balance worked out in contra fund managers’ favor since they bought stocks at low value. Contra fund managers believe that this strategy works in all market phases provided the stocks are based on strong fundamentals.

What are contra funds?

Contra funds belong to the category of diversified equity mutual funds. Contrarian or contra funds are the funds which work against the market trends. Contra fund managers do not want to be a part of herd mentality and they pick underperformed stocks at low prices on the assumption that these will give superlative returns in future. The contra fund managers intentionally make a portfolio of stocks which were rejected by other investors. As per SEBI regulations, contra funds have to invest at least 65% of total assets in equity and equity linked instruments.

What do contra fund managers think of contra investing?

Contra fund managers are of the opinion that the value of an asset gets distorted both by under-performance and over-performance. The core assumption behind this thought is that any unusual change in the price of an asset will gradually normalize in the long-term once fundamentals becomes strong. Having said that Contra mutual fund invests in stocks at a value lower than its expected value in the long-term. There is always one or the other sector which is experiencing a slump because of market conditions. Contra fund managers then study about these sectors and if perceived profitable then invest in these sectors. Fund houses, once invested in contra funds, holds onto them till maturity.

Who can choose contra funds?

Contra investing requires patience from investors since amount is being invested in underperforming stocks. The underperformance can be of multiple reasons and investors must wait till these reasons are mitigated. Once the funds start performing then investors could see their portfolios getting multiplied. Therefore, these funds are not for the investors who are thinking of fulfilling shorter term financial goals. Investors should keep in mind that these funds will give superlative returns in longer run and are not suited for short term investors. Additionally, the risks associated with contra funds in shorter run is comparatively high since these funds do not chase the market trends and underperform in bull phase.

Hence, investor should consider investing in a Contra mutual fund if they have a reasonable risk appetite, an investment horizon of 5 or more years, and lot of patience.

The misconception

People usually think contra fund investing is just about buying those stocks that nobody would like to purchase but this is not true. Contra funds invest in those companies that have strong fundamentals but share prices have dwindled because of some reason like business setback, stringent regulations, loss of earning etc. Often, contra funds’ portfolios would include blue-chip firms having strong fundamentals but not performing well. This does not mean that other investors would not like to purchase the stocks; they are just waiting the trigger to settle down. On the contrary contra funds are purchasing these stocks because they can purchase at lower prices and bet on superlative returns in future.

Investors should take care of two things while putting funds in contra funds:

Returns

Contra funds are for long term goals and investors must wait five or more years patiently to reap higher returns. Once the stocks start performing after experiencing a slump phase then investors can get superlative returns. Investors can earn higher returns since they purchased stocks at lower value. Mutual fund experts suggest that up to 25 percent of the investment can be invested in contra fund.

Risks

Rigorous research and analysis are required for investing in contra funds. The whole idea of contra investing is based on the assumption that the stocks that are lower priced presently will perform well in the future to give superlative returns. There may be times when lower priced stocks remain underperformers owing to market conditions then investors must bear all the risk. Investors should note that it is not always possible to know the future trends of the stocks with 100% surety.

Given below is the list of some of the top performing Contra mutual funds:

Conclusion

Investors cannot make the returns of contra funds as the basis for further investment decisions unlike other equity funds. One must research about the fund manager, its schemes and underlying themes. If the offered investment options match your long-term financial requirements, then you should invest provided you have lot of patience and risk tolerance. Experts also suggest not choosing new fund offer while investing in contra funds.

Happy investing!