Contra mutual fund is an equity based investment scheme that deploys contrarian strategy with an eye on fundamentally good stocks that are under-valued or not popular in the market. It aims at capitalizing on future growth opportunities when the market sentiment shifts.
This article will explain what a contra mutual fund is, their working mechanism, and their major characteristics. This article also talks about the investment in contra funds in India, why people choose it and tax guidelines of such funds.
What are Contra Mutual Funds?
Contra funds are equity mutual funds with a contrarian investment strategy, taking advantage of market inefficiencies by investing in low-priced stocks. These funds invest in companies with strong fundamentals but are experiencing temporary market difficulties. By using a counter-cyclical approach, the top contra mutual funds aim to gain long-term returns as they take advantage of such market inefficiency. As per the SEBI rules, such funds must have at least 65 per cent of the total assets in equity and equity-related securities.
Key Concept Behind Contra Funds
The primary concept of contra funds is to benefit from temporary market inefficiencies. When investor sentiment falls for a certain stock or sector, its price may fall below its intrinsic value. Contra fund managers identify such opportunities and buy stocks with the hope that the prices would ultimately increase, once the market situation normalizes or the company can improve the fundamentals of the business.
Features of Contra Mutual Funds
- Philosophy of investment: Contra Mutual Funds uses a contrarian strategy of investing in stocks that are out of favor but are potentially growing.
- Volatility: These funds may be more volatile compared to normal mutual funds since they invest in companies which are experiencing temporary problems.
- Risk-reward profile: They have high-risk, high-reward potential. It has an opportunity to generate incredible returns when the contrarian investments pay off, but it also comes with the risk of below-average performance when the picked stocks fail to recover.
- Long term investment period: They are suited to those investors that can absorb the fluctuations of the market and have a long investment period (5+ years).
- Minimum Investment: The minimum amount of investment varies depending on the particular fund.
How Does a Contra Fund Work?
Contra funds are an investment fund whose strategy is to be contrarian, in other words, betting against the established market view.
- Finding underpriced stocks: The fund manager searches for stocks that have been unpopular in the markets but are expected to improve soon, or those that have had some temporary problems, such as bad publicity or sector-specific corrections, but have potential to recover
- Value investing: The general principle is to buy shares considered to be cheaper than their actual worth. This intrinsic price shows the long-term potential of the company which includes future earnings, assets and competitive advantage.
- Using inefficiencies of the market: The fund takes advantage of poor prices on stocks so that when the prices finally adjust to match the actual value of the stocks, the fund makes profits.
- Long-term view: Contra funds are designed for long-term investors. Over 5+ years, these contrarian investments could lead to major gains if the undervalued stocks appreciate.
Advantages of Investing in Contra Mutual Funds
Here are some benefits of putting money into contra funds:
- They have a better chance of earning positive returns because they invest in stocks that are fundamentally strong and bought at a lower price.
- They also come with less downside risk compared to large cap, multi-cap, mid-cap, and other equity funds.
- Contra Fund requires a very low minimum investment, which makes it accessible to retail traders.
Therefore, top contra funds are an excellent option for investing in undervalued stocks that could improve in value over time. It is crucial to carefully think about the associated risks and your own risk tolerance before making an investment.
Who Should Invest in Contra Funds?
Contra mutual funds are ideal for:
- High risk investors: Contra mutual funds are suitable for those who can handle high risks since they involve underperforming stocks or underperforming mutual funds that might grow in the future.
- Long term investors: Best suited for investors with long-term outlook who can stay invested for several years to realize potential gains.
Are Contra Mutual Funds Right for You?
Contra funds are a promising opportunity to those patient investors who are able to overcome fluctuations in the market in the short-term. These funds invest in undervalued shares especially those which are experiencing some temporary problems because of the economic situation or market situation.
Contra funds may also suit your overall investment strategy as long as you have a long-term investment horizon and can adopt a hands-off approach to market fluctuations. Nevertheless, one must realize that contra fund returns might not come fast and recovery may be a lengthy process.
Limitations of Contra Funds for Short-Term Investors
Contra funds may not suit individuals in search of short term returns or those who are inclined to making emotion-based decisions. The critical points are the disciplined mindset and a proper understanding of the investment strategy, in order to achieve the maximum rewards of this sort of investment.
Risks of Investing in Contra Mutual Funds
The key risks when investing in the contra mutual funds are as follows:
- Such funds simply purchase under-valued stocks with a belief that they will do better in the future.
- Inexperienced investors might not have the required expertise to buy such stocks; it should be left to the experienced investors who have been trained in research and analysis.
- The actions of investment are dependent on the expertise of the fund manager. Without the stocks performing as expected by the fund manager, the investors will suffer losses.
How to Invest in Contra Mutual Funds?
- Set investment objectives: Determine what your financial goals in investing are such as capital growth, wealth building and risk tolerance.
- Available funds: Compare different funds with their performance history, fees, and credibility of the fund manager to find the top contra mutual funds.
- Identify your mode of investment: A lump sum or a systematic investment plan (SIP).
- Meet KYC demands: Ensure that you have the required KYC documents ready to be confirmed.
- Perform your investment: Choose what fund to invest in, specify how much, and go to trading.
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