What Are Contra Mutual Funds?
Summary
Mutual funds have gained traction among youths as well as traditional investors in the recent past. Individuals investing in mutual funds might have different financial goals in mind. While some tend to make money in the long run, others may have long-term goals. SEBI has categorized mutual funds into various classes depending on their associated attributes like risk profile, investment objectives, investment strategy, asset allocation, etc. Some major mutual fund categories include equity mutual funds, hybrid mutual funds, debt mutual funds, balanced funds, gold funds, and index funds.
As for contra-mutual funds, these funds fall in the equity mutual fund category, which are open-ended schemes aiming to generate capital appreciation by predominantly investing in equity and equity-related instruments. Contra mutual funds are known for their against-the-wind investment strategies. Let us dig a bit deeper into what they are and how they work.
What are contra-mutual funds?
Contra mutual funds are differentiated from other funds by their style of investing. Since these funds follow a contrarian approach to investing, the risk and rewards are high. Fund managers adopt this investing style to meet the objective of the scheme.
A contra fund is defined by its unique investing style. In this type of investing, fund managers bet against the prevailing market trends, meaning they invest in assets that are underperforming at that point in time but have the potential to create substantial returns for investors in the long run. However, the risk potential is equally high with these types of funds.
These funds take a contrarian view of an asset, which either witnesses exuberant demand from investors or gets shunned due to short-term triggers or downfall. The asset’s underperformance or outperformance leads to contortion in its value. And that is what contra funds seek to capitalize on. The general belief is that the asset that has decreased in value will stabilize and come to its expected value in the long term once the short-term concerns are mitigated. The beauty of investing in contra mutual funds is that you buy assets at a cost lower than their fundamental value, which might come back to normal or rise higher than that in the long run.
As an investor seeking ways to invest in contra mutual funds, you must note that these funds may not perform in the short term because they invest in stocks and sectors, which are out of favour or witness a slump.
How do contra-mutual funds work?
Contra mutual funds work differently from other MF schemes. However, the ultimate goal of these funds is to earn considerable returns for investors. These funds pursue a strategy that works on the idea that the asset class in which the contra funds invest will improve over time. Fund managers aim to buy undervalued securities at a good bargain.
They invest in various stocks and sectors keeping a long-term investment horizon in mind. These funds are not ideal for all investors, especially those seeking short-term gains or regular income. Since the performance of asset classes is never stable and fluctuates constantly, some investors may not wish to invest in a fund that follows a contrarian investment strategy.
Wrap up
To conclude, contra mutual funds are equity funds that invest against the existing market trends. These funds purchase stocks that are underperforming currently but may outperform in the future, giving substantial returns to the investors. It is worth noting that they also involve high-risk potential, making them less favourable for investors with low-risk profiles.
Whether you invest in contra mutual funds or any other equity scheme, you should note that investments in mutual fund schemes are exposed to market volatility. That means returns are never guaranteed. So, before investing, you should perform adequate research about the fund and read all scheme-related documents carefully.
Frequently asked questions
What should I consider while investing in contra funds?
Investors should look at the past performance of the fund before investing. Some other considerations include assessing your risk tolerance, researching the fund manager, and evaluating the marketing performance. In the contrarian investing style, looking at the performance of the selected stocks and mitigation of dampening factors is crucial. Also, it is vital to understand that contra-mutual funds carry high returns and risk potential. You should be ready for losses if the stocks you invest in do not perform. So, you should invest up to 10% of your portfolio in contra funds, depending on your risk tolerance capacity. You must also research the fund manager’s performance before investing.
Who should invest in contra mutual funds?
While mutual fund investments are all about patience, investing in contra funds requires being a little more patient. Since these funds invest in underperforming assets, investors need to wait till the stocks start performing gain. In the short term, the risks associated with contra funds are higher than other funds performing well. So, contra mutual funds are suitable for those having long-term investment goals.
What should be my investment horizon to earn profits from contra funds?
Contra mutual funds do not chase the momentum of the market. Nor do they bet on the current market favourites. They bet against the trends – the underdog. Hence, they require reasonable risk tolerance, an investment horizon of at least 5 years, and lots of patience.
Is it possible to get a loan against contra mutual funds?
Since contra funds come under equity mutual funds, you can borrow money by pledging them as collateral. Many banks/NBFCs offer loans against contra mutual funds. However, if the value of the pledged securities comes below the amount withdrawn, the borrower needs to submit more securities or pay the outstanding amount.
What are the benefits of contra funds?
Contra mutual funds come with many benefits. The first advantage is you can expect substantial returns in the long run, provided the stocks they buy outperform in the future. Secondly, these funds invest in fundamentally strong companies. So, market volatility or downfalls does not affect your portfolio much. Since these funds purchase underperforming stocks at a price lower than their fundamental value, the investment capital is relatively low.