Contra Mutual Funds – Concept, Investment Approach, Workings, Features & moreLast Updated Date: Nov 16, 2022
Know everything about Contra Mutual Funds here.
The majority of the fund managers adopt a plethora of investing patterns to meet the investment goals of the scheme.
Besides all the funds, investors choose to invest in contrarian mutual funds as they can grab the opportunity to earn significant returns.
No doubt the risk is high, but there is no return without risk. The main agenda of these funds is to match the view of the sentiment of the market.
Even though it isn’t an arbitrary contrarian viewpoint but is based on market analysis and research.
In simple terms, you can say contra funds are the ones that select stocks that are low performing at low prices. It is mainly because they expect the fund to excel in the long term.
About Contra Mutual Funds
Under contra mutual funds, investors most likely invest against the trends of the markets and buy securities that aren’t performing extensively.
Here, the fund manager has a contrarian view of the security. It is both an excessive demand for the stock, and it is also shunned by the buyers.
The value of the fund is most likely to get a distorted value due to the over performance and underperformance. Based on this, the fund manager tries to capitalize on it.
The central belief of the fund managers is that in the long term, the exorbitant price of the stock will come to normal. It happens after the mitigation of the triggers.
The fund manager tends to buy the contra mutual funds at a price that is less than the potential price. Due to the prevailing market conditions, there can be times when sectors will see some slump.
Under the contra mutual funds, the fund managers tend to invest in securities of companies from some sectors. They hold the securities until the demand shoots up.
Above all, you need to know that these funds will perform way far better in the long run. So if you are looking for short term goals, don’t invest in these funds.
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Investment Approach in Contra Funds
Contra is the short form of Contrarian, and these funds are a type of equity funds. You can say these funds have a contrary view of the market.
Basically, the fund manager looks forward to investing in some stocks that are undervalued but look quite promising. They assume that these stocks will offer excellent returns in the long term.
Above all, you need to understand these are way different from value funds are not suitable for the short term.
Here the traders use against the swing trading style where they invest in stocks that are depressed at a particular time.
In the equity markets, the herd mentality is quite common. Often it leads to mispricing of some, even stocks that hold a significant amount of potential.
The main aim of the fund managers is to look and invest in stocks that are mispriced.
The fund holds a belief that when the stock market is working against the market sentiment, the assets are both worth investing in and underpriced.
Usually, when everyone is striving hard and burning bridges to sell their securities. The fund manager under contra fund decides that it is the perfect time to invest in funds that feature low prices.
When the market conditions are adverse, the prices of the funds tend to dip down as compared to their original price.
Hence when you create an undervalued asset, you are most likely to generate returns way more than average returns in the medium or long term.
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Who should Invest in Contra Mutual Funds?
Only specific type of investors can invest in contra mutual funds. These funds are ideal for investors who are knowledgeable, who understand the prevailing macro trends.
Even risk-taking investors can invest in these funds. Additionally, investors must be willing to invest in the long and medium-term.
If you have a short-term investment horizon, then experts don’t recommend this for you. It is mainly because if the market slumps down, the short term funds can’t generate returns.
As an investor, you can use contra funds as a diversification opportunity. You can invest 10 to 15% of the corpus amount in the contra mutual funds.
Mentality of Contra Mutual Funds Investors
Basically, investors investing in contra mutual funds have a herd mentality. So, under this mindset, people blindly follow the trend.
For example, if an investor thinks that a particular stock is performing, almost everyone tends to buy it. Due to this, the price of security shoots up, and it becomes quite expensive.
On the other hand, if some investors reinvest in a stock, then even others will do the same thing without even evaluating the stocks.
It mainly allows savvy investors to grab an opportunity to swoop in and purchase these securities that are underpriced. Investors say that these are potentially high return assets.
You can say contra funds take a pride here as only savvy investors with an eye for details can look out for the underperforming stocks or sectors.
The fund managers mostly assume that the asset will earn its average value in the long term.
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What is unique about Contra Funds?
Often, investors seem to get confused when it comes to investing in contra funds. They say it is like investing in funds that no one buys in the market.
But that is not the reality because people look out for blue-chip companies most of the time. They search for blue-chip funds in contra funds.
Basically, investors want contra funds that hold great potential to earn. To be precise, contra funds only buy those stocks that are sound fundamentally.
Fund managers either buy it through contra or popular opinion. Usually, fund managers have a list of companies that are sound fundamentally.
But before they make any investment decision, they wait for the fund to collapse or some bad headlines.
When either of the things happens, fund managers pick up those stocks. In simple terms, it means that there is a loss of market earning or expectations or even a business setback.
But the catch here is that none of the situations are permanent. Hence, we can say fund managers can invest in contra funds by choosing sound companies.
It all depends upon the market phases and the underlying value of the security.
Does the Contrarian view always workout?
Well, when it comes to the equity market, we just can’t guarantee anything. But before investing in the equity market, you must check the past performance of the funds.
Often investors fall into the triggers, which either makes them buy the stock at exorbitant prices or not buy stocks at all. The prices of the stocks mainly vary due to these unusual triggers.
They are also mispriced due to such things. Above all, the only agenda of investing in these funds is that investors assume that in the long run, prices will normalize. And they will gain some profits.
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How does Contra Mutual Funds work?
Ideally, under Contra Mutual Funds, the fund managers invest in funds that the market doesn’t recognize.
In the long term, when the markets are all set to recover, fund managers can see that the price value of a stock is increasing.
The contrarians have a belief that mispricing of stock mainly happens due to no stock demand or excess stock demand. It also leads to an imbalance in the price.
Thus, when it comes to buying those underpriced stocks, fund managers choose to go against the market. At the time of value realization, the fund managers tend to see a fall in overpriced stocks.
Additionally, the fund managers capitalize on it by earning great returns on the stocks that are performing poorly in the initial stages.
Things to consider before Investing in Contra Mutual Funds
Just like all other funds prevailing in the market, you must consider the past performance here also before investing.
Market performance doesn’t make much sense
Investing here is way different than the growth funds. Under the growth funds, the market performance decides the fund’s overall performance.
But it is not the case with contra mutual funds because of the performance of the selected securities, and factors which determine mitigation play a crucial role.
We can say that investors can earn profits even if the market is not doing that great.
On the other hand, even if the markets are doing great, you can incur losses. But above all, you need to have all the updates on the performance of the market.
Losses are part and parcel
Be it any fund, investors need to know one thing for sure that you can’t ignore failures. Upsets can happen if the tables turn because, in equity markets, we can’t guarantee anything.
In simple terms, when you invest in contra funds, you are most likely to bet on stocks that are underperforming. You can hope that these stocks will perform well in the long term.
If the securities complete as per your benchmark, then you can earn higher returns.
Even if they don’t perform to your expectations, you might incur losses. So you can choose to invest at least 10% of the amount of corpus into contra funds.
Learn about the fund manager
No doubt, your fund manager is only going to handle your funds.
But before handing over your corpus, you need to understand the working style of the fund manager.
It is mainly essential because the performance of the contra funds primarily depends upon the fund manager.
The stocks that he chooses to decide your return amount. Hence, you must check how the fund manager will work.
What are the Risks involved in Contra Mutual Funds?
There is ideally a threat of price trap under the contra funds prevailing, under which the funds are most likely to fall down.
It is mainly because the fund managers believe they will earn a good value in the near future.
The funds that are underperforming in bearish markets also remain the same in bullish markets. These stocks are not likely to increase even if other stocks start performing up to the mark.
Fund managers assume that few years down the line, the securities will eventually reach their real value.
Above all, we can say that before investing in contra mutual funds, one needs to do a lot of research. There is a risk of investing if the market goes down.
Are Contra Funds and Value Funds same?
Value funds are a type of mutual funds, and people often confuse the same with contra funds. But in reality, they are very different.
As per SEBI guidelines, a fund house can either offer value funds or contra funds but not both. Ideally, the value funds the traditional investment strategy.
They also choose funds that are not only undervalued but also have useful fundamental features.
On the other hand, contra funds invest in sectors or securities which are underperforming currently. The underperformance is due to a lack of common essential elements.
Contra Mutual Funds – Conclusion
Hence, we can say that contra mutual funds are a type of equity funds having a contrarian view of the market.
Here, fund managers pick underperforming stocks with an assumption that they will perform well in the future.
You must invest in this fund only if you are looking forward to long term wealth creation. Hence, we advise you to hold the funds for at least 3 to 5 years.
We hope this guide helps you select the right contra funds.
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