Who Should Invest in Contra Funds?

Do you remember when one of your school teachers always supported the last benchers? It might have surprised you as it made no sense. You must have been even more surprised to find out a few of them performing brilliantly in their later life. A contra fund invests in stocks underperforming in the current market situation. The stock may even be in extremely high demand due to its overperformance. In both scenarios, the fund manager tries to capitalise on the distorted asset value preempting a stable return once existing conditions are normalised. 

The basic concept is that a high-priced stock will eventually normalise when the underlying factors resolve. A contra fund manager believes in buying such stocks at a lower price than long-term estimated prices. He may also invest in underperforming sectors and retain them until demand rises. In short, fund managers sail against the wind and invest against the market condition following the contrarian method, which is just the opposite of any traditional method of mutual fund investing and hence tends to be more volatile.

Understanding Contra Funds

A contrarian approach to investing in the market involves fund managers picking up stocks that are unfavoured by mass investors due to temporary economic downturns or negative market cycles. The stocks that are trading at a lower-than-expected value are bought. The factors considered to evaluate the industry's potential are its assets, anticipated future performance, competitive advantage, business models, etc. The fund then invests in the devalued stocks in anticipation of them reaching their actual price in the future and finally becoming profitable. The profitability may depend on the improvement of the company’s fundamentals, an upward trend in business cycles and improved market conditions.

If we consider historical performances, the SBI contra fund has done remarkably well in the past few years. From just 1300 crores of AUM in 2020, it has exponentially risen to Rs. 39,590 crores as of Dec 2024. If you delve deeper, you may notice this staggering increase in AUM is due to several factors.First and foremost, the change in fund manager led to high portfolio churning. Further, it incorporated a section of mid and small-caps in its portfolio for further diversification.

Having said that, there are risks beyond these factors as well. The underperformance of funds if prolonged, may restrict recovery even when the market bounces back. Also, not all fund managers are equipped well to understand or identify a future trend. You can assess now, that contra funds are anything but low risk and do not necessarily guarantee a high return even if historically proven.

Ideal Investor Profile for Contra Funds

If you want to step out of your comfort zone to try out new areas in the mutual fund market, you must consider whether you have these factors assessed while you invest : 

1. Long-Term Investors : By now, if you have understood the functioning of a contra fund, you are sure to judge that this is a long-term investment that takes time, patience and market awareness. Going against the flow requires courage to take risks and patience to enjoy the final return.You need a minimum of 5 years time horizon for the fund to play out and tide over the downturns in the market. 
2. Risk-Tolerant Investors : These funds invest in underperforming stocks, anticipating that they will perform and give you a healthy and higher return in future. However, in a short-term scenario, these funds are highly volatile and prone to market swings. It is obvious that if you are looking for steady, low-risk returns, Contra is not for you. A person with a higher return and risk appetite will only benefit from this type of investment. 
3. Investors Seeking Portfolio Diversification : Despite its high-risk character, it may also help you diversify your portfolio if you are feeling adventurous enough or have some funds to experiment with. A good mixture of large caps, Flexi- caps and contra funds may result in a high-return portfolio with the stability you are looking for.    
4. Market Cycle-Conscious Investors :The contrarian approach is based on the concept of mean reversion which states that stocks eventually return to their fair value after a period of decline. If you understand the market cycles and their patterns of expansion and contraction and can time your entries and exits, you are equipped to take advantage of the functioning of contra funds. But this strategy only rewards those who are patient, can endure short-term fluctuations, and are experienced investors who believe that undervalued stocks will bounce back over time.

Who Should Avoid Contra Funds?

If patience is not one of your virtues you should steer clear of these funds. The minimum investment horizon of contra funds begins at 5 years. The undervalued stocks take time to generate returns as per market cycles.

Being a family man, you might have major financial responsibilities like medical expenses, children’s education etc. It is necessary to evaluate how much returns you may gather with such high risk. Prioritise your financial load and if you seek steady returns and low fluctuation and are in no position to ensure losses, contra funds are best avoided.

It may be psychological but fear of the unknown may also prevent you from testing the waters of this type of investment. Since humans are social beings, you seldom like to go against the flow and would like to stick to the traditional ways of investing. In such conditions, contra funds will be uncomfortable instruments to look for.

Top  Contra Funds

The table below enlists top contra funds sorted by 5 yr annualised returns (on lumpsum investment) that you can consider for investing :

Conclusion

It is crystal clear that contra funds can be a winner if chosen after a lot of research and understanding of the market, entered at the right time and given enough years to take advantage of the market conditions to generate expected returns. So, what you first need to assess and conclude before you decide to get into it, are your risk tolerance level, your investment objective and whether you are comfortable walking the opposite way when all others are earning returns going in similar directions. Once you are clear on all three factors, you can conclude if you are adventurous enough to try on a new concept and are confident enough to come out a winner in the end.