What are CONTRA FUNDS

A contra fund is a subcategory of equity mutual funds and as the name suggests, this is a kind of investment fund whose USP is to adopt a contradictory view of the sentiments flowing in the market. It is based on findings that are extracted after analysis and conducting research about the company and market data. These funds are open-ended equity funds and invest a minimum of 65% of their total assets in equity and equity-related instruments. To understand the working in brief, rather than focusing on stocks that seem promising, here the fund managers place their bets on those companies or industries which are not performing well and are undervalued. Let us discuss the working of these funds in detail.

HOW DO CONTRA FUNDS WORK?

These funds back the belief that when the market sentiment is flowing against a particular company or industry, the stock prices are undervalued offering the best time to invest in them. So, when every other investor is moving away from the company and selling its stock, fund managers of contra funds come into play and decide that this is the ideal moment to purchase the company’s share at a lower price and reap the maximum benefit after the sentiment loses momentum. The adverse market conditions will reduce the stock prices, much under its real value. Investing in these stocks which are undervalued will generate more than average returns in the medium to long-term tenure.
Another belief is that there exists a herd mentality in the market. This means that if certain investors consider a stock promising, everyone will rush to buy it and the stock then gets expensive and overvalued due to market forces. Identically, if some investors start divesting shares of a particular company, then everyone will follow without doing any real analysis on the company itself. This then creates an opportunity for intelligent investors who can buy up these undervalued and high-return potential stocks. The contra funds are also managed by some of these smart investors and fund managers who have these beliefs. In crux, we can say that these funds are managed with the underlying assumption that the asset will stabilize and come to its real value in a long-term tenure.

KEY ASPECTS TO CONSIDER BEFORE INVESTING IN CONTRA FUNDS

1. Past Performance:

Investors must go ahead with an old fund that has the experience and lasted in the market. Nevertheless, you cannot simply look at past results and make a decision. Researching and analyzing the details and assets of the fund in parallel with past performance is the best exercise to do and make a decision.

2. Different Mandates:

Investors should always know that different mandates are followed by different contra funds. This means every contra fund invests in different industries and sectors and has different mandates of the general themes. You should always consider the same and draw up a picture before investing.

3. Fund Managers:

The fund managers are the most important aspect in any fund as these are the people who will be handling your hard-earned money and taking decisions on behalf of you. You should be reasonably comfortable with the skills, ability, and knowledge of the managers that they will gauge the real worth of companies and you will be at ease with the decision they take on your investments.

4. Markets become irrelevant:

As we discussed that these funds are contrarian in nature, they don’t depend on the market conditions as they invest in the selected niche sectors and industries. It is possible that the market is bearish and has crashed but you have gained a profile, and it is also possible that when the markets are bullish and at an all-time high, you may have some losses.

RETURNS ON CONTRA FUNDS

These funds can yield high returns if the stocks have the potential to grow. In the medium to long term, these funds can prove to be a valuable asset. When the market sentiments are against a particular industry or sector, the stocks are purchased at low prices and when the market stabilizes, fund investors can benefit from the increasing prices. Experts and professionals are of the opinion that an allocation to contra funds of up to 10% to 15% of the portfolio could be considered.

RISKS TO CONTRA FUNDS

There may be stocks that are underperforming in bearish markets and remain so in the bullish markets and not grow. Here, the basic assumption of the contra funds fails and the manager might not see gains on those holdings. This threat is called ‘Price Trap’ in which stocks will tend to go down, believing to have a good value choice in the long term. Therefore, a lot of analysis and research is required before investing in the same.

WHO SHOULD INVEST IN CONTRA FUNDS?

These funds are ideal only for a particular class of investors who can do the needful research and analysis with their skills and knowledge, who can understand the macro trends prevailing and also, possess a high-risk appetite. The investors should also have the intention to stay invested for a medium to long term, as in the short run, the stocks may be volatile.

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