Different fund managers of mutual funds adopt different investment strategies to achieve the scheme’s objective. Among the many investment strategies, one of the popular ones is the contrarian style. As the name suggests, in a contrarian style of investment, the fund managers invest in specific stocks that have contradictory market views.

They invest in funds that are not performing well as per the market standards but has the potential to grow in the future. Most investors, especially risk-averse investors, do not invest in such funds as they carry high risk. But, at the same time, these funds have high return potential.

If you are a first-time investor or curious to know more about contra mutual funds, you have come to the right place. In this blog, we explore the different aspects of contra funds.

What are Contra Mutual Munds?

Contra funds invest against the market trend and buy stocks that are performing poorly in the current market situation. The fund manager takes a contrarian view of the stocks that are either not purchased at all or when a particular stock has a high demand for it.

In both cases, when the stocks are under-performing or over-performing, the stocks have a distorted value, and the fund managers investing in contra funds try to take advantage of it. The core idea of contra funds is that any irregular pricing of the asset will normalise in due course when the existing triggers are mitigated.

Now that you know about Contra Fund meaning, let us know about its benefits, who should invest in contra funds, and more.

How do Contra Funds work?

The working of contra funds is quite unique and different from other types of mutual funds. Investments in these funds work on the assumption that the asset class in which the contra funds invest will improve in the future.

The fund managers of contra funds buy the undervalued stocks at a low price and get a good bargain on them. Investments are made considering the long-term potential of these stocks to grow. Hence, if you have short-term goals or want quick returns, you must avoid investing in Contra funds.

While many professionals and experienced investors favour contra funds, a few others don’t. Although it is true that the performance of any asset is never constant, it fluctuates from time to time, and they are subject to market volatility, investors in contra funds leverage the high risk-reward potential.

Benefits of investing in Contra Funds

• One of the biggest benefits of investing in contra mutual fund schemes is that you can expect high returns if the stocks you invest in perform well and their value increases. Since the stocks in which contra funds invest are cheap, the profit margin is big.

• Typically, fund managers of contra funds assess the underperforming funds and invest only in funds of strong companies with high potential to grow. So, even when the market is not performing well, your portfolio might not take a huge hit.

• The minimum investment amount required for contra funds is very low, which allows all retail investors to invest in it.

Who should invest in contra mutual funds?

Contra mutual funds can be an ideal investment option for you if you are willing to take high risks in exchange for high returns potential. Also, you must invest in these funds only if you are willing to stay invested for a long time before expecting any returns.

Additionally, you must also know that contra funds, in comparison to other mutual fund schemes, carry a high expense ratio. So, if the funds don’t perform well, you will continue to incur losses over time.

Thus, if you are looking for short-term investment options, expecting quick returns and don’t want to take risks, contra funds are off-limits for you.

Also Read – Expense Ratio

Factors to consider while investing in Contra Funds

Whether you are a first-time investor or a pro, before you invest in any mutual fund scheme, it is paramount that you read everything you can about the scheme and assess its past performance before putting in your hard-earned money. Also, here are a few other critical things to consider when you invest in a contra mutual fund scheme in India.

• Market performance is not relevant

  When you invest in stocks, the performance of the overall market plays a huge role in the returns you get. If the market goes upwards, you can expect high returns and vice-versa. But, with contra fund investments, it is the performance of the selected stocks and mitigation of other factors dampening the stock value that are critical to the returns you get.
  
  Hence, in a contrarian style of investing, you can get high profits even if the overall market is going the other way, and you may book losses when the market is at its peak. So, when investing in contra mutual funds scheme, you must keep yourself abreast with the performance of the stocks you are investing in.

• Do your research well about the fund manager

  The credibility and reputation of the fund manager is critical to the scheme’s performance as they are responsible for choosing the right stocks to invest in that have the potential to grow in the long run. They must have the acumen to assess the stock’s potential.
  
  Hence, as an investor, you must do your research well about the fund manager’s credibility, reputation and performance.

• Know about the risks involved

  One of the most important things to understand about contra fund investment is that you are placing your bets on low-performing stocks with the hope that their value will increase in the future. So, while you can expect high returns if the stocks’ value goes up, you must also be aware of the risk involved and be prepared to face losses if the stocks don’t perform well.
  
  Hence, investment experts worldwide suggest that contra fund must not be more than 10% of your investment portfolio.

Tax implications on investments in Contra Funds

If you have invested in contra funds and want to redeem the investment within 12 months from the date of purchasing the funds, then the returns you earn will be subject to STCG (short-term capital gains) tax at a flat 15%.

However, if you stay invested for more than one year and redeem the investment after that, then the profits you earn will come under the LTCG (long-term capital gains) gamut. And, if the profit is not more than Rs. 1 Lakh, then you are eligible to get tax exemption.

But if your capital gains are more than Rs. 1 Lakh, then the amount beyond the limit will be taxed at 10%.

Let us understand the taxation on contra funds with an example.

Suppose in a particular financial year, you earned long-term gains of Rs. 1.5 lakhs from contra funds. In this case, Rs. 1 Lakh will be exempted from tax, and the balance amount of Rs. 50,000 will be taxed at 10%. This means you must pay a tax of Rs. 5000.

Note - This is only for illustration purpose and not actual performance.

Also Read – Mutual Fund Taxation

To Conclude

It is pivotal that you understand the risks involved with investing in Contra Funds and invest in it only if you have the capacity to take such risks. Also, you must do your research well, and if needed, consult your financial advisor before investing in a contra mutual fund scheme.

Mutual Fund investments are subject to market risks, read all scheme related documents carefully.