Contra mutual funds are gaining investors’ interest as they offer the potential for high returns in a market that is otherwise volatile. These funds invest in stocks that are out of favour with the market and focus on taking contrarian investment bets – bets on high quality stocks which have turned out of favour, cyclically. With indices at highs, concerns around the broader market peaking out and valuations are steering investors towards bargain hunting.
The contra and value funds have done well post-March 2020 and continue to do well today also. While returns are one parameter, market conditions also play an important role in investing and the conditions post-Covid have been in favour of a few funds in these categories.
Potential value
Contra investing seeks to invest in stocks that are far from their potential value and are cyclically trading at relatively lower valuations. Nirav Karkera, head, Research, Fisdom, says at a time when most high-quality companies appear to trade at relatively higher valuations, it may indeed be a prudent strategy to invest in contra funds. “There is lot of opportunity across market segments, but slightly elevated valuations across many build a case for incremental allocation towards contra funds,” he says.
Currently, some sectors are performing well while others are struggling. Sonam Srivastava, founder & fund manager, Wright Research, says this makes it a good time for investors to consider investing in contra funds, as they can help to diversify their portfolios and reduce their risk. “However, it is important to remember that contra funds are still a high-risk investment, and investors should only invest in them if they are comfortable with the possibility of losing money,” he adds.
Contrarian investing involves going against prevailing market sentiment. Harish Menon, co-founder and head of Investments and product research, House of Alpha, says the fund manager aims to identify undervalued assets that are expected to perform well in the long term, even if they are currently out of favour. “Contra investing is more a function of opportunities available in the market rather than expected to do well/poorly in certain market conditions,” he says.
Risk-return reward
While the returns earned by contra funds can be very high, the risks are also high. Though there are a limited number of contra opportunities in the market, these opportunities can be very rewarding. There could be phases where these funds underperform their peers from other categories.
According to Harshad Chetanwala, co-founder, MyWealthGrowth.com, allocation in these funds can help in diversifying the style of fund management within the portfolio. “A minimum of five to seven years should be the time horizon just like other equity-oriented mutual fund categories,” he says.
Most contra funds have been able to deliver strong risk-adjusted performance across longer periods, through cycles. While opportunities are always available it will be difficult for any fund management team to keep identifying such opportunities consistently and time the entry/exit in such stocks. “Considering the diverse universe and depth, there are enough contra opportunities available for such funds to invest almost every time,” says Karkera.
Factors to consider
Before investing in contra funds, investors must check the fund manager’s investment style, risk-adjusted performance across cycles, and fund performance specifically in context of cycles and portfolio composition. For instance, the sectoral composition of the fund reflects the fund’s contrarian stance to some extent. Check the history of entry/exits to figure out if the fund managers have been able to identify contra opportunities on an ongoing basis. “Sometimes the fund may be named contra but majority of the holdings could be index hugging or in line with the momentum sectors/stocks. In such cases, it is not really investing in contra opportunities,” says Menon.
The ideal investment period for contra funds is three to five years. This is because it takes time for undervalued stocks to recover their value and for contra funds to generate significant returns. However, investors can also invest in contra funds for shorter periods of time, but they should be aware that the risks are higher. Srivastava of Wright Research, advises that individuals should start investing with a small investment and increase it over time. “Diversify portfolio by investing in multiple contra funds and rebalance your portfolio regularly to ensure that your investments are still aligned with your risk tolerance,” she says.
GOING AGAINST THE TIDE
- The ideal investment period for contra funds is three to five years
- The returns can be very high, but the risks also tend to be high
- Most of such funds have delivered strong risk-adjusted performance across longer periods, through cycles