What Should You Know About Contra Fund?

Contra funds are a unique type of mutual fund that aims to generate returns by going against prevailing market trends. They take a contrarian view by investing in stocks that are out of favor with investors but have strong long-term potential. While most funds follow the crowd and invest in rising stocks, contra fund do the opposite by identifying undervalued stocks that are trading at a discount to their true worth. They believe short-term factors are causing temporary underperformance, and the market will eventually recognize the stock’s intrinsic value internet chicks. This contrarian approach allows contra funds to deliver returns with low correlation to the overall market movements.

What are Contra Funds?

Contra funds are a unique type of mutual fund that aims to generate returns by going against prevailing market trends. The name ‘contra’ comes from the Latin word ‘contra’ which means ‘against’. Simply put, try to profit from falling or underperforming stocks while most other funds invest in rising stocks. Contra funds look to identify stocks that are currently out of favour with investors but have strong long-term prospects internetchicks. 

How do Contra Funds Work?

Contra funds work by analyzing company fundamentals and identifying stocks that are trading at a discount compared to their true value. The fund managers believe short-term factors are causing the stock price to underperform when the long-term outlook remains positive. Some common reasons why stocks may be undervalued include negative sentiment due to temporary issues, lack of analyst coverage, unrealistic market expectations, etc. 

Advantages of Contra Funds

• Diversification: Contra funds provide diversification from the overall market by investing in stocks moving in the opposite direction. This helps reduce portfolio risk.
• Potential for higher returns: By betting against the crowd, stand to gain significantly when their contrarian calls play out. Returns can be well above market averages over long periods. 
• Hedge against overvalued markets: Contra stocks act as a hedge when the broader market is overvalued and due for a correction. This limits the downside in falling markets.
• Tax efficiency: Long-term capital gains from equity mutual funds are taxed at just 10% if the units are held for over 1 year. This makes tax efficient.

Risks of Contra Funds

• Increased volatility: As go against the tide, their NAVs will be more volatile than regular equity funds in the short run.
• Market timing risk: The fund manager must correctly time market shifts for the contrarian calls to succeed. Mistimed bets can lead to losses.
• Liquidity issues: It may be difficult to exit positions in illiquid small-cap stocks held by contra funds during market downturns. 
• Higher research burden: Picking winning contra stocks requires extensive research few retail investors have the ability or time for.
• Manager dependency: Success is highly dependent on the fund manager’s stock selection ability and investment horizon.

Who Should Invest?

Contra funds are best suited for investors with the following profile:

• High risk appetite: Willing to take on higher volatility for the potential of above-average long-term returns.
• Long investment horizon: Need to stay invested for 5-7 years at least to ride out interim market fluctuations. 
• Understanding of market cycles: Able to analyse companies and have faith in fund managers’ contrarian calls. 
• Seek true diversification: Want investments uncorrelated to broader market movements for portfolio balancing.
• Limited exit requirements: Not dependent on short-term liquidity from the investment. But do check for exit load on mutual funds, in case the need arises to withdraw. For instance, exit load for SBI Contra Fund is 1% if redeemed within one year.

New investors or those averse to risk should start with a small allocation to get comfortable with contra fund investing.

Conclusion

Contra funds are a specialized category best suited for investors with high-risk appetite and long investment horizons. While they carry additional risk compared to regular equity funds, can deliver superior returns when their contrarian calls play out. With proper research and by understanding market cycles, have the potential to enhance portfolio returns and provide true diversification.