Learn the basics of contra funds

When you invest in contra funds, you need to have a long-term perspective

June 06, 2012 5:29 IST | India Infoline News Service
‘Majority wins, minority loses!’ is the first thing we learnt when we played as kids. This is because we are trying to determine as to who will give the ‘den’ first. As children, we don’t even know the meaning of majority and minority, except the fact that the person who is the ‘odd one out’ has to give the ‘den’ first.

As we grow up, we are conditioned to do what the majority do— because that is the ‘right’ thing according to most of us. If you don’t follow the herd, then you may be a ‘loser’.

The ‘majority wins’ phrase could also be relevant in case of investors, where herd mentality is quite common, and in some cases—has been the one of the reasons for creation of various market bubbles witnessed in the past.
On the other hand, we have another school of thought, which believes in ‘contrarian-investing’ and considers that herd-mentality among investors can lead to imbalances in the market place.  Based on this style of investing is the contra fund (short form for contrarian).

What are contra funds?

As the name suggests, contra funds take a ‘contrarian’ view on equities. Generally speaking, a contra fund is just another type of an equity mutual fund that has a contrarian view to investment which is supposed to be the opposite of the view that regular mutual funds’ take.

A contra fund is one that invests in stocks that are ‘out-of-favour’ with investors and are being sold or avoided by them but have the potential to provide good returns in the long term. 

In the long run, it has been seen that market price of a stock tends to reflect its underlying fundamental strengths. In the short term, however, negative perceptions and market sentiments may affect stock prices of good companies. There could be fundamentally strong companies which could trade at prices significantly lower than their intrinsic values. Contrarian investing refers to the strategy of identifying and investing in such stocks and waiting for the market to realise their true values.

According to Pankaaj Maalde, head-financial planning, Apnapaisa.com, contra fund invests in under performing stocks or sectors which are likely to perform good in the coming years. Fund manager takes a contrarian view against the current market trend.

Some of the contra funds are ING Contra, Kotak Contra, L&T Contra, SBI Magnum Contra, Religare Contra, Tata Contra and UTI Contra.

Investing strategy

The fund manager picks underperforming stocks or sectors, which are likely to perform well in the long run, at cheap valuations. A contra fund takes into account the intrinsic growth potential of a stock since the current price may not reflect the actual value. Hence, the aim is to tap the price advantage by investing in stocks which are not very popular investment destinations and thus increase the prospects of outperformance.

How to choose a contra fund?

The factors which we consider while selecting contra funds are different from the selection criteria of a regular diversified equity fund. Investors must look at the mandate of the fund and the themes it invests in. They should also check the past performance of the fund manager, his experience in managing mutual funds or contra funds and the themes he invests in. 

How are these funds taxed?

If you sell the units in less than a year, the returns are taxed at 15%. If you hold them for over a year, the gains are tax-free. Mr Maalde adds, 'Securities transaction tax (STT) is levied at the time of redemption of units which is 0.2% at present and no STT is levied at the time of purchase of units.”

Remember, when you invest in contra funds, you need to have a long-term perspective.

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