Investing in Mutual Funds: Should Contra Funds Be Part of Your Investment Portfolio?


Matching funds are generally cyclical in nature and generate high returns after a relatively long gestation period.

“Contra” comes from the word contrarian, which basically means going against the prevailing norms. Contra mutual funds, typically equity in nature, invest in themes and stocks that are underperforming and currently underperforming, but nonetheless have strong fundamental values. Thus, these funds take a contrarian view and bet on stocks that are expected to perform in the future. Matching funds are generally cyclical in nature and generate high returns after a relatively long gestation period.

Fund managers in contra mutual fund schemes basically look for undervalued stocks that have not participated in market momentum for various reasons. Undervaluation factors could range from regulatory actions to economic cycles or unexpected events that may have temporarily put the company’s performance under pressure. Thus, the fund manager tries to capitalize on these investment opportunities with research-based conviction.

That said, contra funds are not intended for investors. They are relatively riskier funds in the short term with intensely non-linear and unexpected performance. Such schemes not only take time to generate a return, but they may not be suitable for a short-term financial goal with a duration of 2-3 years.

Who should invest in Contra funds?

Investors should know their risk profile and ability to take risk before considering matching funds. Furthermore, it also requires an understanding of the investment behavior of investors. These funds require your patience, a high capacity to absorb shocks and the willingness to invest more if the value of the fund’s assets deteriorates further. Therefore, investors who have a moderate to high risk appetite, who have time on their hands, and who can remain disciplined in their approach without pressing the panic button can opt for contra funds.

Should you invest in Contra funds?

A relatively higher risk/reward ratio over the long term makes matching funds extremely attractive. There would be continuous ups and downs, but you would be forced to stay put during the trip. It is also possible that the value of the investment is several times lower than your costs. These phases should be used to accumulate more units through additional purchase features, which in turn contributes to the average cost.

For example, matching funds from three large, well-known fund houses gave year-over-year returns of 84.4%, 54.5%, and 57%, respectively. For three years, returns have settled at a compound growth of 23.5%, 18% and 18.1%, respectively, according to data available online as of October 1, 2021. However, there have been phases where these funds have even lost more than 30 to 40% of their values. This indicates the risk associated with these funds.

Contra funds could be part of your satellite funds around your core long-term investment portfolio. They help diversify your overall portfolio and go a long way in building wealth with a long wait. During cycles where benchmark stock indices are not performing, contra funds can add additional value to your investment. And when broader markets are outperforming, contra funds can underperform.

Precautions to take when investing in Contra funds

Although the Indian mutual fund industry offers nearly 1,500 schemes across all asset classes, currently only 19 matching funds are available to investors. Since there are fewer of them managing relatively fewer assets, investors should take the following precautions before moving forward.

a) Past performance: While choosing contra funds, investors should review the past performance of these funds before investing. This helps to understand the performance cycle of the fund and thus investors have a fair idea of ​​the time they need to stay loyal to the fund.

b) Limit your allowance: Ideally, the allocation to matching funds should be limited to no more than one-fifth of all investments. High risk takers who are seasoned investors may choose a higher exposure given their risk appetite.

c) Do not sell when the value deteriorates: Belief with patience is a must while investing in contra funds. It is advisable not to panic and to repurchase in the event of a drop in value. Rather, an investor should use these market conditions to buy more in order to spread holding costs.

d) Accounting benefits at the end of the cycles: Contra funds may not be suitable for staying beyond their outperformance at the end of their performance cycle. Timely redemption of matching funds contributes to wealth creation. Consider taking advice from your advisor or relationship manager on when to trade.

Conclusion

Contra Funds have the potential to add significant value to your overall investment portfolio. However, they require much more patience and unwavering conviction from investors due to their long gestation period to generate returns. You should consider contra funds if you are a seasoned investor who is familiar with market cycles and has relatively high risk-taking capabilities should go ahead with contra funds.

(The author is CEO, BankBazaar.com)

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