As an investor, if you are looking to diversify your portfolio, if you have moderate experience and a willingness to take calculated risks, then contra funds can be a valuable addition to your portfolio.
Let us explore what contra funds are, why they might be a good investment, and their risk-return profile.
What are Contra Funds?
Contra funds are equity mutual funds that follow a contrarian investment strategy. Fund managers invest in stocks that are undervalued or out of favor with the market but have strong potential for future growth. The assumption is that these stocks will recover and generate significant returns over time. This strategy is backed by thorough research and analysis of market cycles, economic conditions, and business fundamentals.
According to the Association of Mutual Funds in India (AMFI), contra funds fall under the Equity Mutual Fund category and must maintain at least 65% of their portfolio in equities and equity-related instruments.
Why Invest in Contra Funds?
Investing in contra funds can be beneficial for several reasons:
1. Long-Term Growth Potential
Since contra funds invest in undervalued stocks, they offer the potential for strong gains when the market corrects itself.
2. Diversification
These funds invest across sectors, reducing sector-specific risks.
3. Market Inefficiency Advantage
Contra funds take advantage of market inefficiencies where stocks are mispriced due to temporary negative sentiments.
4. Professional Management
The fund managers employ deep research and historical trends to identify potential turnaround stocks.
Top Contra Funds in India
Below is a comparative analysis of some of the top-performing contra funds based on their 1-year and 3-year returns, Total Expense Ratio (TER), and Asset Management Company (AMC):
Contra Funds with 1-year and 3-year Returns
| Sr. No. | Fund | 1-Yr Return | 3-Yr Return | TER | AMC |
|---|---|---|---|---|---|
| 1 | Invesco India Contra Growth Direct Plan | 10.45% | 19.33% | 0.56% | Invesco Mutual Fund |
| 2 | SBI Contra Growth Direct Plan | 4.31% | 24.11% | 0.60% | SBI Mutual Fund |
| 3 | Kotak India EQ Contra Growth Direct Plan | 3.37% | 19.85% | 0.60% | Kotak Mahindra Mutual Fund |
Source: Kuvera, Feb 26, 2025.
Risks and Returns Profile
While contra funds offer significant upside potential, they come with their own set of risks. Let us explore the risk and return profile of the contra funds.
Return Potential of Contra Funds
Contra funds follow a value-investing approach, meaning they seek out stocks that are currently undervalued or out of favor but have strong long-term growth potential. Based on the provided table, the return profile of contra funds varies depending on the investment horizon:
1. Short-Term Returns (1-Year Performance)
- Invesco India Contra Growth Direct Plan has the best short-term return (10.45%), suggesting that the fund has been able to capitalize on recent market trends effectively.
- SBI Contra Growth Direct Plan (4.31%) and Kotak India EQ Contra Growth Direct Plan (3.37%) have relatively lower 1-year returns, indicating that their portfolio stocks might still be in the recovery phase.
Key Insight
In the short term, contra funds can be volatile, as they invest in underperforming stocks that may take time to appreciate. The 1-year return fluctuation suggests that short-term investors might not see immediate gains and should have a higher risk tolerance.
2. Long-Term Returns (3-Year Performance)
- SBI Contra Growth Direct Plan leads with 24.11% over three years, indicating that its investment strategy has played out well over a longer period.
- Kotak India EQ Contra Growth Direct Plan (19.85%) and Invesco India Contra Growth Direct Plan (19.33%) have slightly lower but still competitive long-term returns.
Key Insight
This demonstrates that contra funds work best over longer investment horizons as they wait for undervalued stocks to recover. Investors with a long-term perspective (3-5 years) are likely to benefit the most.
Risk Factors of Contra Funds
While contra funds have the potential to generate high returns, they come with inherent risks:
1. Market Volatility Risk
- Since contra funds invest in stocks that are temporarily out of favor, short-term price fluctuations can be significant.
- The 1-year return variation (from 3.37% to 10.45%) suggests that different funds have different levels of short-term volatility, influenced by their specific stock selection.
2. High Dependence on Market Cycles
- The performance of contra funds relies heavily on market corrections—they perform well when the market recovers, but they may underperform during prolonged downturns.
- The 3-year returns (ranging from 19.33% to 24.11%) indicate that these funds have performed well recently, likely benefiting from a market upswing. However, past performance is not a guarantee of future results.
3. Fund-Specific Risks (Expense Ratio Impact)
- Total Expense Ratio (TER) affects returns since it represents the cost of managing the fund.
- Invesco India Contra Growth Direct Plan has the lowest TER (0.56%), which means investors retain more of the returns.
- SBI Contra Growth and Kotak India EQ Contra Growth have slightly higher TERs (0.60%), which may slightly reduce net returns over time.
Key Insight
Investors should consider the TER while choosing a fund, as lower expense ratios can enhance overall returns in the long run.
Final Takeaways
- For investors seeking short-term gains, Invesco India Contra Growth Direct Plan looks more favorable due to its strong 1-year performance and lower TER.
- For long-term investors, SBI Contra Growth Direct Plan is a strong contender given its best 3-year returns.
- Kotak India EQ Contra Growth Direct Plan has performed modestly but remains a reliable option within the contra category.
Wrapping Up
Contra funds are a unique investment option for investors who have a long-term perspective and are willing to take moderate risks. These funds leverage market inefficiencies to buy undervalued stocks, offering the potential for superior returns. However, patience and an understanding of market cycles are crucial for investors opting for this category. If you are looking to add contra funds to your portfolio, consulting with a financial advisor and assessing your risk appetite is essential before making any investment decisions.
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