What is a Contra Mutual Fund? A Complete Beginner’s Guide

Introduction

Why Contra Mutual Funds Are Gaining Investor Interest

How many times have you seen a company rise or a multibagger stock yield gains, and wondered what the profit would have been had you invested early on? A type of mutual fund that follows this idea is called a contra mutual fund. 

Contra mutual funds have been attracting the attention of investors and shares advisory services, due to their unique investment approach. In a market where most investors chase trends, these funds take the opposite route. They invest in stocks or sectors that are out of favor but have strong fundamentals. This contrarian strategy has helped some investors identify value where others overlook it.

Who This Guide is For and What You’ll Learn

If you’re new to mutual funds, it’s essential to understand how to combine the concepts of different mutual funds with tax aspects, such as TDS in India and tax on mutual funds. After clarifying the concepts and starting your mutual fund portfolio journey, if you are looking to diversify your investment style, this guide is for you. You’ll understand what is contra fund is in a mutual fund, how it works, and whether it fits your financial goals. 

What is a Contra Mutual Fund

Contra Fund Meaning in Mutual Fund Terms

A contra mutual fund invests against prevailing market sentiment. It picks undervalued stocks or sectors that are currently ignored or disliked by the broader market. These funds believe such stocks will recover in value over time.

How Contra Funds Follow a Contrarian Investment Strategy

The idea behind a contra fund in mutual fund investing is to go against popular opinion. When everyone sells a stock due to short-term issues, these funds might see it as a buying opportunity if the long-term outlook is positive. It’s all about identifying potential early.

SEBI Classification and How It Differs From Other Equity Funds

SEBI classifies contra mutual funds under the equity category. What sets them apart from other equity funds is their contrarian approach to stock selection. While most equity funds follow growth or momentum strategies, contra funds aim to find value in neglected areas.

How Contra Mutual Funds Work

Investment Philosophy Behind Contra Funds

Contra mutual fund follows a contrarian investment approach. It invests in stocks that are currently undervalued or out of favour with the broader market but have strong fundamentals and long-term potential. The assumption is that these stocks are mispriced due to short-term sentiment and may recover in value over time.

When Fund Managers Invest Against Market Trends

Contra funds invest in sectors or stocks when the market is moving in the opposite direction. For example, if a particular industry is currently facing weak demand, the fund may invest in it, assuming conditions will stabilise. The aim is to enter when valuations are low. These decisions are based on research into company performance, sector outlook, and market behaviour. The fund may hold these positions for extended periods until valuations adjust.

Example of a Contra Mutual Fund Stock Pick Strategy

Consider a scenario where a pharmaceutical stock declines due to regulatory issues, but the company’s pipeline and financials remain robust. While others may avoid the stock, a contra mutual fund might see this as a good entry point. Contra funds use such scenarios to build positions early.

Benefits of Investing in Contra Mutual Funds

1. Potential to Capitalize on Undervalued Stocks

These funds can benefit from early investments in undervalued stocks. If the market eventually recognizes their value, it could result in significant gains.

2. Diversification Across Cyclical Sectors

Because they avoid the herd mentality, contra funds often invest across various sectors, including those overlooked by other funds. This helps with diversification in both the portfolio and the investment style.

3. Long-Term Wealth Creation in Volatile Markets

Their ability to stay invested in unpopular sectors enables them to perform better during uncertain times, thereby supporting long-term wealth creation.

Risks and Limitations of Contra Funds

1. Requires Patience and Long-Term Commitment

Contra mutual funds invest in stocks that are undervalued or temporarily out of favour. These investments may take time to deliver returns. Stocks may remain underpriced for extended periods, which means that contra funds may not perform in line with broader market expectations in the short term. This long holding period can result in an opportunity cost if the expected turnaround doesn’t occur.

2. May Underperform in Bull Markets

When markets are rising and popular stocks are performing well, contra funds might lag because their focus is on undervalued or out-of-favour stocks, which limits exposure to momentum-driven gains.

3. Not Suitable for Short-Term Investors

Contra funds are built for long-term investing. If you’re looking for quick gains or reacting to short-term market shifts, these may not suit your goals. The strategy relies on holding undervalued stocks until the market realigns, a process that can take time. Returns also depend on the fund manager’s judgment, so reviewing their track record and approach is important before investing.

Who Should Invest in Contra Mutual Funds

Investor Profile Best Suited for Contra Strategy

Contra funds suit investors with a contrarian mindset—those willing to invest in out-of-favour but fundamentally strong companies. They are ideal for value-focused individuals who can stay invested during market volatility and avoid reacting to short-term trends. These funds also appeal to those who prefer professional fund management and want to diversify their portfolio with less correlated assets.

Time Horizon and Risk Appetite Considerations

A minimum investment horizon of 5 years is often recommended. Along with this, you should also have a moderate to high risk appetite.

Contra Fund vs Value Fund: Key Differences

Contrarian vs Value Approach

Both contra and value funds look for undervalued stocks. The difference is in their strategy. Value funds focus strictly on valuation metrics. Contra funds look at market sentiment along with valuation.

When to Choose One Over the Other

You can choose contra funds if you believe in long-term turnarounds driven by changing sentiment. Or, you can opt for value funds if you’re focused purely on undervaluation based on fundamentals.

Aspect	Contra Fund	Value Fund
Investment Approach	Invests in underperforming, out-of-favour stocks expecting recovery	Invests in fundamentally strong but undervalued stocks
Risk Profile	Higher risk due to going against market trends and longer downturn exposure	High risk from holding undervalued stocks, which may stay low for extended periods
Time Horizon	Long-term (5-7 years) to ride out market cycles and realize gains	Long-term (5+ years) to allow value realization
Liquidity Risk	Relatively higher, due to a focus on out-of-favour stocks	Lower but still present, based on undervalued stock liquidity
Investor Profile	Aggressive, high-risk investors are comfortable with volatility	Risk-tolerant, value-focused investors with patience
Investment Goal	Seek higher returns through contrarian bets on turnaround stocks	Seek capital appreciation by investing in undervalued companies

Conclusion

Are Contra Mutual Funds the Right Fit for You?

Contra mutual funds offer a different perspective on investing. If you are willing to take a patient approach and avoid following the crowd, this strategy could complement your portfolio.

Final Thoughts on Building a Balanced Portfolio with Contrarian Strategies

You can include contra mutual funds as part of a diversified portfolio. It’s also advisable to seek professional guidance to align your investment strategy with your financial goals. Additionally, consider tax implications, like taxes on mutual funds and available exemptions vs deductions, when planning your investments. Always conduct thorough research before making any financial decisions.

Disclaimer Note: The securities quoted, if any, are for illustration only and are not recommendatory. This article is for education purposes only and shall not be considered as a recommendation or investment advice by Equentis – Research & Ranking. We will not be liable for any losses that may occur. Investments in the securities market are subject to market risks. Read all the related documents carefully before investing. Registration granted by SEBI, membership of BASL & certification from NISM in no way guarantee the performance of the intermediary or provide any assurance of returns to investors.

FAQs on Contra Mutual Fund