Should you invest in contra funds? Find out here

Are you looking to invest against existing market trends? Do you seek an against-the-wind investment style that may help you earn an inflation-beating return? You could invest in contra funds that get their name from the word ‘contrarian’. It is an equity fund that follows an against-the-wind trading style by investing in underperforming stocks or sectors at that particular time. The fund manager picks up the stocks of companies with strong fundamentals that are unpopular because of a specific situation. Should you invest in contra funds?

What are contra funds?

You have contra funds following a contrarian investment strategy. According to SEBI rules, contra funds invest a minimum of 65% of total assets in equity and equity-related investments and must follow the contrarian investment strategy.

The fund manager of contra funds selects stocks of fundamentally strong companies that are unpopular because of a particular situation. Moreover, the fund manager intentionally goes against market sentiment and purchases underperforming sectors when others are selling and vice versa. 

For instance, a contra fund manager may purchase IT stocks when the rupee is appreciating against the dollar. A strong rupee may affect the profits of these companies, and they are generally dumped in this scenario. However, the fund manager picks IT companies with solid fundamentals and waits for the rupee to depreciate against the dollar. 

The fund manager of contra funds assumes that stock prices would stabilise once the short-term triggers affecting the company become irrelevant. It leads to the market realising its true potential, and the stock price rises over time.  

Should you invest in contra funds?

You may consider investing in contra funds if you are an aggressive investor with an investment horizon of over five years. However, it helps if you are patient, as markets may take time to recognise the true potential of a company or sector. Moreover, the fund manager invests in stocks across market capitalisation.

You could invest in contra funds if you understand the market trends. It helps if you stay in control of your emotions as these funds follow an against-the-wind investment strategy and go against the market trend. 

You may find contra funds vulnerable to the price trap. These funds work on the assumption that prices of underlying stocks would eventually rise over time. However, changes in the economy or a drop in the company’s fundamentals may force the fund manager to sell the stocks at a loss.

You have contra funds taking a bet on a particular sector, making it a hazardous investment. Moreover, you may find the investment underperforming during a bull market as many investors avoid stocks that don’t offer a higher return in a short time. 

Are contra funds the same as value funds?

You will find many investors mistaking value funds for contra funds. However, value funds follow the traditional value investing strategy. The fund manager selects stocks of fundamentally sound companies that are out of favour with investors and are available at a lower price. 

You have fund managers of value funds picking stocks of companies whose intrinsic value is above the current market price. 

However, the fund manager of contra funds picks stocks or sectors currently underperforming because of short-term concerns. SEBI, the capital market regulator, has instructed mutual fund houses to offer either a contra fund or a value fund. 

You may invest in contra funds to achieve your investment objectives if it matches your risk profile. It helps if you check the AMCs track record and the fund manager’s investment style before investing in the contra fund. In a nutshell, you may invest in a contra fund if you prefer investing in stocks and sectors currently underperforming but have future potential.

For any clarifications/feedback on the topic, please contact the writer at cleyon.dsouza@cleartax.in