Investors use different strategies and techniques to achieve the common goal of making profits and appreciating their wealth. Some may believe in investing money when the market is soaring high, while some may prefer to invest in fundamentally strong companies, which is not that popular yet. Contra investing is the strategy of focusing on underpriced and undervalued assets that have a scope of growth in the future, but are currently unpopular.
This article contains a detailed explanation of contra funds and helps you understand whether you should invest in them or not.
Understanding Contra Funds
Contra funds are a type of equity mutual fund that employs a contrarian approach to investing, which involves purchasing stocks that are currently underperforming because of short-term problems but are anticipated to rise in value over time.
Key Features:
- The contrarian philosophy concentrates on industries or stocks that are momentarily unpopular.
- Investing in undervalued businesses with strong foundations is known as the value-oriented approach.
- Active fund management is done in this case, and strict stock selection necessitates skilled fund managers.
- In order to balance risk and reward, diversification in contra funds typically includes a mix of large-cap, mid-cap, and sometimes small-cap stocks, as well as exposure to different sectors and industries
For instance, a contra fund might purchase inexpensive, fundamentally sound IT stocks in the hopes of long-term growth, although many investors may not be interested.
Pros and Cons of Contra Funds
Pros:
- Purchasing undervalued but fundamentally sound stocks that have a high potential return when markets correct is known as value buying.
- Profitable entries are frequently the result of taking advantage of short-term market overreactions.
- Portfolio diversification reduces an excessive reliance on growth or momentum funds by adding a contrarian investment style.
Cons:
- May underperform in Bull Markets, and returns may be slower during market rallies.
- Value picks might take a while to recover, which could irritate investors with short-term goals.
- The manager’s timing and judgment play a major role in returns.
- It can be challenging to cope with volatility and brief underperformance.
Who Should You Consider Investing in Contra Funds?
1. Perfect for Volatile Phases and Market Corrections
- Many stocks with strong fundamentals trade below their intrinsic value when the market is down and investor sentiment is negative.
- Contra funds spot these chances and purchase high-quality stocks at a discount.
- Typical growth funds may underperform during market downturns as they maintain exposure to high-growth stocks that are more affected by negative market sentiment.
2. Fit for Long-Term Investors Looking to Create Value
- It takes time for the contrarian strategy to build wealth. It could take months or even years for stocks or industries that aren’t doing well to recover.
- Short-term investors might not see the returns they expect and might sell too soon, missing the opportunity to profit.
3. Good at Diversifying a Growth-Oriented Portfolio
- Contra funds add a degree of diversity to a portfolio that is mostly made up of momentum or growth funds.
- This can lessen the volatility of the entire portfolio, particularly in situations where market sentiment is overly positive or negative.
The comparison table below will help you understand the difference between a contra and a growth fund:
| Parameter | Contra Fund Approach | Growth Fund Approach |
| Market Sentiment | Invests against prevailing sentiment | Invests with prevailing sentiment |
| Focus | Undervalued or ignored sectors/stocks | High-growth potential companies |
| Performance in the Bull Run | May underperform | Typically outperforms |
| Performance in Corrections | May outperform due to value opportunities | Likely to correct along with the market |
4. Favored by Investors with Moderate to High Risk Tolerance
- Because contra funds typically invest in unpopular industries or stocks, they may perform poorly in bull markets.
- You should have faith in the fund’s long-term potential and be psychologically ready for short-term performance lags.
5. Making Wise Decisions When Markets Seem Overpriced or Overheated
- Investing in mainstream equity funds can feel risky during periods of overvaluation or excessive market optimism.
- Contra funds, which concentrate on cheap stocks, may feel safe.
Bottomline
The conclusion can be drawn that contra funds are a good investment option for those who believe in fundamentally strong stocks that are currently undervalued and have long-term growth potential. While these funds may offer attractive returns over the long run, they can be volatile and are not immune to market corrections or uncertainty. Investors should be prepared for periods of underperformance and have a long-term investment horizon.
Also, they should decide whether they are interested in entering the mainstream and popular equity stocks or prefer those that provide better opportunities in the future.