Best Contra Mutual Funds - MF Explorer

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Contra Funds

What is a contra fund?

According to SEBI’s categorization of mutual fund schemes, a contra fund is an open ended equity scheme that should follow a contrarian investment strategy. Being an equity scheme, the contra fund should invest at least 65% of its total assets in equity and equity related instruments. According to SEBI guidelines, a fund house can only offer a value fund or a contra fund and not both.

What strategy does a contra fund follow?

Contrarian investing, as the name indicates, is a style of investing that involves picking stocks that do not follow the market trend. In other words, a contrarian investor will seek to find opportunities where others don’t – which means going against popular trends, market sentiment and herd mentality. A contra fund investment style seeks to identify opportunities where a stock is mispriced. The reasons for such mispricing could be many, such as the company being in a turnaround phase, or the sector being out of market favour, going through a down-cycle and so on. This investment style is based on the higher payoff that comes when the stock or sector is rerated as growth comes in. A contrarian investing style portfolio could include underperforming stocks / sectors and defensive stocks and seeks to capitalize on the opportunities presented by mispricing.  

This investing style usually takes time (years) before the investments yield results. It also carries a higher degree of risk of making the wrong calls. A contra fund, therefore, could see phases of underperformance where it can lag the benchmark or other funds.

There can be a lot of overlap between contrarian investing and value investing. A value investment style seeks opportunities where the price of a stock does not yet reflect its value, but does not necessarily have to be completely against the market grain. How a contra fund defines what is contrarian, what is value, and to what degree it follows a contrarian/value approach depends on the fund and can vary with funds within the contra/value category.

Where do contra funds invest?

Since contra funds are equity schemes, at least 65% of the total assets will have to be invested in equity and equity related instruments. A contra fund is typically a multi-cap one, investing across the market capitalization range. A contra fund may also be benchmark-agnostic when it comes to sector or stock weights as they seek to go against the tide.

However, due to their multicap nature, a contra funds can have significant overlaps with funds from other categories. For example, a contra fund that is predominantly large-cap may be similar to a large-cap fund. a fund that is more aggressive in investing across market capitalisations could be similar to a multicap or a flexicap fund.

This apart, contrarian investing is a strategy. A fund that belongs to another equity category can also have a similar strategy, without classifying itself into the contra/value category. For example, value or contra-based large-cap and flexi-cap portfolios could share similarities with contra fund portfolios. For these reasons, a contra fund needs to be compared with similar funds from other categories as well, in order to correctly judge performance.

What is usually the benchmark index?

The benchmark index is the index against which the fund’s performance is evaluated and also what the fund seeks to outperform, being an actively managed scheme. The commonly used benchmark indices for contra funds include S&P BSE 500 TRI, Nifty 50 TRI, Nifty 100 TRI and Nifty 500 TRI. The benchmark index can be an indicator of the market-cap orientation the fund may follow.

What is the nature of returns?

Contrarian investing seeks to achieve capital appreciation in the long term and when it works, it can be very rewarding. However, this could be unpredictable and take several years to play out and for the markets to see value in the contrarian out-of-favour stocks to re-rate them. These would therefore need to be held for a minimum of 5 to 7 years and in the meantime, especially in the short to medium term, could see underperformance. Volatility may also be common with contra / value investing.  This makes it a high risk – high returns investing style and suitable only for those who can handle periods of underperformance.

Suitability and how to use

Contra funds follow a high risk – high return path to capital appreciation in addition to being equity focused and therefore, usually take 5 to 7 years to work. Due to this, it would suit investors with a moderate to high tolerance for risk in addition to having a time horizon of at least 5 years.

A good contra fund can be used as a part of long term, high risk portfolios and along with growth funds / index funds to build a balanced portfolio with a mix of investment styles. This will help ensure that a portfolio does not suffer from poor returns during the phases where a contra/value style investing underperforms.

Taxation

  • IDCW distributions are taxed at the hands of the investor at the applicable tax rate.
  • Short term capital gains (holding period less than 12 months) are taxed at 15%. Long term capital gains (holding period of 12 months or more) above Rs. 1 lakh are taxed at 10%.

How to evaluate contra funds?

Contra funds can be hard to gauge given the investing style; the fund portfolio over different periods needs to be seen to understand how the fund defines contra and how its contra bets have delivered. Consistency of historical performance vis-à-vis the benchmark and peers, historical volatility and fund manager performance can all offer insights. Periods of underperformance in relation to market cycles can also be seen.

Which contra fund to invest in?

Prime Funds will tell you which contra funds you can consider adding to your portfolio and how.

 

General Disclosures and Disclaimers
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