Contra Funds – Definition, Advantages & Risks

What are Contra Funds?

Contra funds are equity funds, which invest in equities with a contrarian view on the market. Fund managers of these funds bet against prevailing market trends and sentiments. They pick up undervalued but fundamentally sound stocks, ignored by the market, at lower prices to benefit from steep rises in them as and when the market takes note of these stocks. As per SEBI regulations, contra funds have to invest at least 65% of total assets in equity and equity linked instruments.

Why invest in a Contra fund?

• Identifies and invests in hidden or ignored investment opportunities
• Can earn superlative returns as stocks with sound fundamentals are bought at lower cost and sought to be sold when the broader market takes not of them
• Have lower downside risk when compared to other large cap, multicap, midcap and other equity fund categories as the portfolio constituents of contra funds trade at discounts relative to their past valuations
• Can serve as good hedge during overvalued market conditions against market corrections

Difference between value and contrarian style of investing

Value funds and contra funds are similar in the sense that both of them base their investment decisions primarily on the basis of valuation comfort offered by their scrips. However, there is a thin line of difference between contrarian and value investing. While value investing focuses on the gap between the intrinsic value and trading price of the shares, contrarian investing focuses on out of favour but fundamentally sound stocks trading at a lower prices than their recent past, and not necessarily at discount to their intrinsic value.

Performance of Contra Funds

(Data as on 27^th April 2021, Source: Value Research)

1. Invesco India Contra 

• Chooses companies with sound fundamentals and potential to grow in long run
• Invests across market capitalization
• Prefers companies in turnaround phase and trading below fundamental value
• Also considers growth companies with attractive valuations
• Takes active underweight/overweight sector positions vis a vis its benchmark.

2. Kotak India EQ Contra

• Follows bottom-up approach to identify investment opportunities across market capitalization with a large cap bias
• Prefers fundamentally sound companies with attractive valuation and long term growth potential
• Identifies attractive valuation through early recognition of positive changes in the fundamental of the underlying business, like considerable cost cutting, launch of new products, expansion of distribution network, consolidation in industry, etc
• Estimates intrinsic value of the companies on the basis of their:
• financials
• future growth potential
• range of product and services
• acquisition value of similar companies in comparable times
• management quality
• competitive position in the industry

3. SBI Contra Fund

• Follows a combination of bottom up and top down approach to stock pricing
• Invests at least 65% of its total assets in stocks fitting the contrarian investment style

Risks of investing in Contra Fund

• Contra funds can fall into price trap where their underperforming constituents continue to underperform for longer than expected, forcing the funds to sell the securities at loss or for very low returns
• Contra investment calls can take exceptionally long time before getting the desired attention of the other market players 

Who should invest in Contra Funds

• Investors preferring undervalued stocks overlooked by the market
• Those wishing to contain their downside risk in overvalued market conditions
• Those having enough patience to wait for the contra plays to work out
• Those who do can check their emotions during the market volatility
• Those having long investment horizon, five years at least, and preferably 7 years and above to derive maximum benefit from an entire investment cycle