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Every investor’s approach to the financial market is different. They are backed with strategies supporting their individual thoughts and financial objectives. One such unique approach towards the market’s analysis is the contrary approach.
Have you noticed in your informal group that there is always one friend disagreeing with the group’s opinion and thinking differently? That’s how contrarians work, too. Today’s article deals with the meaning of contra fund and the contrarian approach to investing, particularly in the mutual fund market.
What is a contra fund?
A contra fund is a mutual fund plan where the fund manager invests in stocks that are currently underperforming. So, the fund consists of stocks that are downtrending. Such funds work against the usual market trend.
The normal practice while investing is to follow the trend. But, the contra fund’s investment strategy is to move against the market’s trend. The contra fund is an equity fund and invests more than 65% of its assets in equity-based instruments.
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The contrarian approach
The contrary approach, as the term suggests, is where the investor’s thoughts are contrary to market sentiments. These investors break the herd mentality of following others and go against the trend.
The idea behind the contrary approach is that the market cannot be in the same direction for a long time. The trend has to reverse. Contrarians aim to make profits when such reversals happen.
Contrarians believe that the market is influenced by a herd of investors, because of which it is trending in a particular direction. However, they expect the pressure to come down and the market to correct itself, and hence invest in the opposite direction.
For example, when investors are selling stocks, contrarian investors look for buying opportunities. Contra investors make money by buying shares when stocks are underperforming, so they can profit by selling them when the stock increases its performance.
Features of a contra fund
- Contra funds are riskier than regular funds. Contrary investors expect the market to change its direction in the future, which may or may not happen.
- Like the risks, the returns are also high in a contrary fund.
- A major portion of contra funds are invested in equities. Generally, 65% of funds are invested in stocks.
- Fund managers of contra funds operate with a different mindset. While a large portion of investors trade with market sentiments, contra-fund managers look for opportunities to go against it.
- The market takes a long time to change its direction. Hence, contra fund is not ideal for short-term investors. It is suitable for those who wish to make profits in the long run.
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Benefits and risks
The primary benefit of a contra fund is its ability to generate very high profits. Since the cost of these stocks is usually low, they are lucrative when the market corrects itself. Fund managers often look for stocks of well-performing companies to minimise the risk of loss if the market does not correct itself.
The obvious risk of contra funds is the high ability to lead to losses. A thorough analysis and an experienced fund manager are required to handle contra funds to ensure the possibility of profits.
Contra fund tax rates
Contra funds are equity-based. Hence, their taxation follows similar rates, too.
- Dividends – Taxed as per income tax rate
- Short-term capital gains (< 1 year) – Taxed at 15%
- Long-term capital gains (> 1 year) up to ₹1 lakh – No tax
- Long-term capital gains (> 1 year) > ₹1 Lakh – 15%
Bottomline
Investors with a high-risk appetite but also seeking professional management of their funds can try their luck at contra mutual funds. The fund managers of such funds think differently from the majority of investors and invest against the trend.
Though a highly risky bet, the possibility of returns is equally high, making this a thrilling investment avenue worth trying.
FAQs
Both contra and value funds follow an unconventional investment strategy. While contra fund invests in underperforming stocks, value fund invests in undervalued stocks. The objective is to make profits when the performance and value rise during a market correction.
Since these fund managers follow a strategy that is different from the normal approach, and contrary to the strategy of a majority of investors, it is called the contra fund.
Contra funds are not safe investments. They are highly risky since the investment involves low-performing stocks. Their performance may not improve as expected, causing unlimited losses.
The well-known and top-performing contra funds are:
SBI Contra Direct Plan-Growth, Kotak India EQ Contra Fund Direct-Growth and Invesco India Contra Fund Direct-Growth
It is a good time to buy a contra fund if your risk tolerance level is high and you are looking at a medium to long-term investment option. Stocks take at least 3-5 years to correct themselves and benefit contra investors.
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