Browse through the history of Indian equity markets, and you will find several stocks that were once under-performers and then turned into multi-baggers for the investors. Experienced equity investors know that even under-performers or stocks that are currently not trending hold massive potential at times.
There is a specific type of mutual fund, contra fund, that aims to deliver capital growth by investing in such stocks. If you are not sure what is contra fund in mutual fund and whether you should invest, read on to know more.
Contra funds derive their name from the word 'contrarian.' The fund managers of these schemes have a contrarian market view. They have an against-the-wind trading style where they invest in stocks that are depressed or under-performing at that particular time.
Herd mentality is very common in the equity markets. This often results in the mispricing of even stocks that hold a lot of potential. The fund managers of contrarian schemes search and invest in such mispriced stocks.
While nothing is guaranteed in the equity market, top contrarian funds have been able to deliver impressive returns in the past. The concept behind them makes sense, as well. Often, there are short-term triggers that make investors avoid or exuberantly purchase a particular stock.
This unusual evasion or demand results in mispricing of the underlying stock. By investing in such stocks, a contra fund assumes that the price of the stock will stabilise in the near future once the short-term triggers are mitigated or become irrelevant. The stock will then come to its real value in the long run and benefit the investors.
Value funds are also a type of mutual fund, and people often get confused between the two. But they are very different. In fact, SEBI has made it clear that a fund house could only offer either value funds or contra funds, but not both.
Value funds, as the name suggests, follow the traditional value investing strategy. Value funds prefer stocks that are currently under-valued but have decent fundamental characteristics. Contra funds, on the other hand, select sectors or stocks that are currently underperforming due to short-term concerns. The underperformance is generally not because of poor fundamental characteristics by short-term triggers or concerns.
Now that you have a brief understanding of what is contra fund, do you think that they should be part of your portfolio? It is recommended that people aiming for long-term wealth creation and are not risk-averse should prefer investing in contra funds.
A lot of times, the underperformers selected by contra funds take a lot of time to start performing. So, only invest in a top contra fund if you can remain invested for at least 3-5 years.