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What are Contra Mutual Fund Schemes?

9 Mins 25 Jul 2023 0 COMMENT

In India, there are 43 mutual fund houses that manage public money via about 1,400 mutual fund schemes. Each scheme has its own investment style, philosophy and strategy, however, all of them have been broadly categorised into certain categories.

These categories have been defined by the market regulator Securities and Exchange Board of India (SEBI). Each mutual fund house is allowed to have just one scheme under one category. One such category is contra fund.   

What is Contra Fund?

A contra mutual fund is a type of mutual fund that takes a contrarian approach to investment. Instead of investing in stocks that are popular and performing well, a contra fund manager will look for opportunities to invest in stocks that are currently out of favour or undervalued.

The idea is that by taking a contrarian approach, the fund manager can identify stocks that have the potential to perform well in the future, but that may be overlooked by other investors.

As per SEBI guidelines, a contra fund needs to invest 65% of the funds in equity. The rest can be invested elsewhere. SEBI mandates that a fund house can either offer a contra fund or a value fund. As of January 2023, there are 22 schemes offering products following either contra strategy or value investing strategy.

Usually, in a contra fund, underperforming but quality stocks and sectors are bought at low price points with an expectation that they will perform in the long run. Typically, contra fund portfolios include beaten-down stocks and defensive stocks that performed poorly or gave negative returns during bear markets.

Industry body Association of Mutual Funds in India (AMFI) warns that contra funds carry the risk of getting calls wrong as catching a trend before the herd is not possible in every market cycle and these funds typically underperform in a bull market.

Who should invest in contra funds?

Contra mutual funds can be a good option for investors who are willing to take on a higher level of risk in exchange for the potential for optimised returns. Many times, investors have to remain invested for a long time before their investment bear fruits. Thus, contra mutual funds are not for those that have no patience.

It is also important to keep in mind that the performance of contra funds can be volatile, and there is no guarantee that they will outperform the market over the long term.

Additionally, one should also note that contra funds typically have higher expense ratios than other types of mutual funds. Thus, if the fund is not performing in a cycle, your losses will continue to widen over time.

What to consider before investing in contra mutual funds?

High gestation period

If you are investing in a contra fund, you should be patient. Moreover, you should be investing for the long term as the fund can continue to underperform for the long term. Hence, invest only that capital that you do not need in the near term.

High risk

Contra funds are inherently riskier. Since the fund bets on underperforming stocks, there is no guarantee that they will start to perform. There is always a risk that such stocks continue to bleed money. Thus, only those investors who can tolerate losses should invest in contra funds.

High risk is also the reason that one should not invest a large chunk of the capital in contra funds. The fund should never be part of your core portfolio.

Fund manager

In high-risk strategies, it is important to research the fund manager as a lot depends on the prowess of the person managing money. If the fund manager has the reputation to pick winners from a pile of garbage, they can perform relatively better than other peers. One should always research the fund manager before investing in contra funds.

Market performance

The overall market’s performance does not determine the expected returns in the contrarian style of investing. The returns here mostly depend upon the selected stocks and their performance. Hence, the broader market performance has no relevance in the performance of a contra mutual fund scheme. Rather than gauging the overall market strength, it is essential to assess the performance of the stocks in the contra mutual fund scheme.

In conclusion, it is critical to note that the contra mutual fund scheme should be preferred by those with a higher risk appetite. Investors must do their research, understand the risks involved and consult with a financial advisor before investing in a contra mutual fund scheme.

Disclaimer: ICICI Securities Ltd. (I-Sec). Registered office of I-Sec is at ICICI Securities Ltd. - ICICI Venture House, Appasaheb Marathe Marg, Prabhadevi, Mumbai - 400 025, India, Tel No : 022 - 6807 7100. I-Sec is a Member of National Stock Exchange of India Ltd (Member Code :07730), BSE Ltd (Member Code :103) and Member of Multi Commodity Exchange of India Ltd. (Member Code: 56250) and having SEBI registration no. INZ000183631. AMFI Regn. No.: ARN-0845. We are distributors for Mutual funds. Mutual Fund Investments are subject to market risks, read all scheme related documents carefully. Name of the Compliance officer (broking): Ms. Mamta Shetty, Contact number: 022-40701022, E-mail address: complianceofficer@icicisecurities.com. Investments in securities markets are subject to market risks, read all the related documents carefully before investing. The contents herein above shall not be considered as an invitation or persuasion to trade or invest.  I-Sec and affiliates accept no liabilities for any loss or damage of any kind arising out of any actions taken in reliance thereon. The contents herein above are solely for informational purpose and may not be used or considered as an offer document or solicitation of offer to buy or sell or subscribe for securities or other financial instruments or any other product. Investors should consult their financial advisers whether the product is suitable for them before taking any decision. The contents herein mentioned are solely for informational and educational purpose.