Mutual Fund Investment: Should Contra Funds be part of your investment portfolio?

By: |
October 25, 2021 11:31 AM

Contra funds are generally cyclical in nature and generate high returns after a relatively long gestation period.

Contra Funds have the potential to add significant value to your overall investment portfolio.

‘Contra’ comes from the word contrarian, which essentially means going against prevailing norms. Contra mutual funds, typically equity in nature, invest in themes and stocks which are non-performers and depreciated currently but nevertheless have strong fundamental values. So, these funds follow a contrarian view and bet on stocks that are expected to perform in the future. Contra funds are generally cyclical in nature and generate high returns after a relatively long gestation period.

The fund managers of contra mutual fund schemes essentially look for those undervalued stocks which have not participated in the market momentum for various reasons. Factors for undervaluation could stretch from regulatory measures to business cycles or unexpected events that might have temporarily put the company’s performance under pressure. So, the fund manager tries to capitalise on such investment opportunities with a research-based conviction.

Having said that, contra funds are not for investors. These are relatively riskier funds in the short term with an intensely non-linear and unexpected performance. Such schemes not only take time to generate a return, but they may not be suitable for a short-term financial goal with a tenure of 2-3 years.

Who Should Invest In Contra Funds?

Investors need to know about their risk profile and risk-taking capacity before considering contra funds. Besides, it also requires an understanding of investors’ investment behaviour. Such funds demand your patience, high shock absorption capacity, and willingness to invest more if there is further deterioration in the value of the fund’s assets. Therefore, investors who have moderate to high risk appetites, have time in hand, and can remain disciplined in their approach without pressing the panic button may opt for contra funds.

Should You Invest In Contra Funds?

A relatively higher risk-to-reward ratio in the long term makes contra funds extremely attractive. There would be continuous sharp ups and downs but you would be required to stay put during the journey. There could also be a possibility that the value of the investment goes below your costs several times. Such phases should be used to accumulate more units by way of additional purchase features, which in turn, helps in cost averaging.

For instance, contra funds from three large, well-known fund-houses have given one-year returns of 84.4%, 54.5% and 57%, respectively. For three years, returns stood at a compounded growth of 23.5%, 18% and 18.1%, respectively, as per data available online on October 1, 2021. However, there have been phases where these funds even lost over 30-40% of their values. This indicates the risk attached with such funds.

Contra funds could be among your satellite funds around your core long-term investment portfolio. They help in diversifying your overall portfolio and considerably help in creating wealth with a long wait. During cycles when the benchmark market indices don’t perform, contra funds may add additional value to your investment. And at times when broader markets show outperformance, contra funds may be underperformers.

Precautions To Take While Investing In Contra Funds

Though the Indian mutual fund sector offers nearly 1500 schemes across the asset categories, there are only 19 contra funds currently available to investors. Since they are fewer in numbers managing relatively fewer assets, investors should exercise the following precautions before going ahead.

a) Past Performance: While choosing contra funds, investors should review the past performance of such funds before investing. This helps understand the fund’s performance cycle and thus investors get a fair idea of how long they need to stick to the fund.

b) Limit Your Allocation: Ideally, one should restrict allocation to contra funds at not more than a fifth of the overall investments. High risk takers who are seasoned investors may choose higher exposure given their risk appetite.

c) Don’t Sell When Value Deteriorates: Conviction with patience is a must while investing in contra funds. It’s advisable not to panic and redeem when there is a downfall in value. Rather, an investor should use such market conditions to buy more to average out the holding costs.

d) Book Profits When Cycles End: Contra funds may not be suitable to stay with beyond its outperformance upon completion of its performance cycle. A timely redemption from contra funds helps in wealth creation. Consider taking advice from your advisor or relationship manager when to redeem.

Conclusion

Contra Funds have the potential to add significant value to your overall investment portfolio. However, they demand much more patience and unshakeable conviction from investors due to their long gestation period to generate returns. You should consider contra funds if you are a seasoned investor who is well-versed with the market cycles and have relatively high risk-taking capabilities should go ahead with contra funds.

(The writer is CEO, BankBazaar.com)

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