Contra Mutual Funds – What is It?, Risk, Features, & Recommendations

The Indian equity markets have had several stocks that would under-perform at the start and then contribute significantly to investor wealth as their prices rise. Most experienced equity investors swear by many under-performing stocks that may currently look unattractive but hold immense potential to rise in value. So, how do new investors identify such stocks?

This is when contra funds come into the picture. These funds aim to deliver capital growth through investment in such stocks. Read on to find out more about this interesting investment concept and how it works.

What are contra mutual funds?

Contra funds are equity mutual funds that primarily invest in equities. These funds adopt a contrarian view of the market. To put it simply, Contra fund managers place their bets against the prevailing market movements. They invest in undervalued stocks that are fundamentally sound, stocks that are not preferred by the market. These stocks often come at lower prices and therefore contra funds can benefit from sharp rises in the prices of these stocks if and when the market takes note of them. 

As per SEBI norms, contra funds are required to invest a minimum of 65% of total assets in equity and equity linked instruments.

How do contra mutual funds work?

Contra Funds invest in stocks that the market generally does not recognize. It aims to see a price-value increase of these investments when markets recover. Contra funds are based on the idea that lower or no stock demand may lead to market mis-pricing. Investors often adopt a herd mentality of investing in trendy stocks, which could be overpriced. Contra Fund managers foresee a price fall of such stocks and then, once their value is realized by the market, they capitalize these by earning high returns from the once poorly performing stocks.

Reasons to invest in a contra fund

Here are some of the top for investors to consider investing in contra funds:

1. Identifies undervalued or ignored equity investment opportunities and invests for long-term gains.
2. Has higher chances of gaining positive returns since selected stocks have sound fundamentals and are purchased at a lower cost.
3. Comes with lower downside risk in comparison to large cap, multi-cap, mid-cap and other equity funds. This is because the stocks in a contra fund trade at discounts relative to their historical valuations.
4. Acts as a hedge against market corrections during overvalued market conditions

What are the risks involved in contra funds?

Some risks of investing in contra funds are:

1. Contra funds are based on the underlying assumption that investments will reach their real value. However, there are chances of this being proved wrong.
2. Investing in Contra Funds requires a lot of research and analysis. Therefore, these may not be ideal for new investors.
3. The investment selection depends on the fund manager’s expertise. In case the stocks perform against the fund manager’s expectations, investors may also suffer losses.

How are Contra Fund Investments Taxed?

Contra funds belong to the equity mutual funds category. Therefore, the income from contra funds is taxed like any equity fund. Here are some important points on applicable tax:

• Dividends earned from any mutual fund are taxable in the hands of investors as per applicable slab rates.
• Short-term capital gains from sale of fund units within a one-year holding period are taxable at 15%. This is irrespective of an investors’ income tax slab rate.
• Long-term capital gains of maximum Rs. 1 lakh through sale of fund units after completion of one year holding period are tax-free. Any additional gains are taxed at 15%.

Who should invest in contra funds?

Investors who want to explore undervalued stocks that are often overlooked by the market can invest in contra funds. Generally, following type of investors prefer these funds:

1. Those who want to limit their downside risk during overvalued market conditions
2. Investors who can remain invested till the stocks attain expected valuation
3. Ideal for long investment horizon of approximately five – 7 years

Contra fund recommendations

Here’s a look at some of the top-performing contra funds:

1. SBI Contra Fund
   The scheme aims to provide the investor with long-term capital appreciation through investment in a diversified portfolio of equity and equity related securities. It follows a contrarian investment strategy.

Inception Date	Jan 01, 2013
Benchmark Name	S&P BSE 500 Total Return Index
Fund Manager	Dinesh Balanchandran
Expense Ratio	1.62%

Historical Returns of the Fund (annualised)

1-Year	2-Year	3-Year	5-Year	Since Inception
100.15%	23.73%	14.86%	14.64%	13.82%

2. Kotak India EQ Contra Fund
   The scheme aims to achieve capital appreciation by investing in equity and equity related instruments. It invests in stocks of companies that are undervalued but fundamentally sound.

Inception Date	January 01, 2013
Benchmark Name	NIFTY 100 Total Return Index
Fund Manager	Shibani Kurian
Expense Ratio	1.04%

Historical Returns of the Fund (annualised)

1-Year	2-Year	3-Year	5-Year	Since Inception
66.27%	18.34%	15.27%	17.78%	15.90%

3. Invesco India Contra Fund
   The scheme aims to generate capital appreciation through investment predominantly in Equity and Equity Related Instruments. While doing so, it adopts a contrarian investing view.

Inception Date	January 01, 2013
Benchmark Name	S&P BSE 500 Total Return Index
Fund Manager	Taher Badshah
Expense Ratio	0.56%

Historical Returns of the Fund (annualised)

1-Year	2-Year	3-Year	5-Year	Since Inception
61.47%	19.12%	14.44%	18.48%	18.95%

Conclusion

While investing in contra funds, investors need to carefully study the fund’s aim and the themes used for investment. It is important to be in agreement with the fund manager’s investment perspective to make the most of contra funds.

FAQs

1. Are contra funds good?
   Contra funds are a good investment option for long-term and may not perform well in the short-term because of the assets they invest in. These funds buy assets at a lower cost than its expected fundamental value in the long run.

2. What is a contra fund?
   A contra fund adopts an ‘against-the-wind’ investment style. The fund manager of a contra fund invests against the prevailing market trends and by purchasing assets that may be under-performing currently. These investments are selected because of their strong fundamentals.

3. Who should invest in a contra fund?
   A Contra Fund does not go with the market flow or bet on current market favorites. It bets on the undervalued stocks. Hence, investors who have a reasonable risk tolerance and an investment time horizon of over 5 years can consider investing in contra funds.

4. Are contra funds risky?
   Contra funds are often risky in the short term as they wait for the prices of investments within the portfolio to rise. This is generally a long-term game and therefore, investors must remain invested for the long-term to reduce the risk element in contra fund investments.

5. Do contra funds generate positive returns?
   Contra funds may generate positive returns depending on factors such as, fund manager’s experience and expertise in stock selection, appropriate current valuation of chosen stocks and also rise in long-term stock prices as per manager’s expectations.

Related Links

• Smart Recommendation Engine
• Index Funds Vs Mutual Funds – 5 Major Differences
• What are Mutual Funds and how do they work?
• India’s Best Mutual Fund APP
• Best mutual funds for retirement planning