Contra fund investing is about going against the tide. Over the past few years, contra funds have yielded good returns with SBI Contra Fund leading the pack by posting 23.34 per cent returns in three years.
However, over the past six months, contra funds have not done all that well. Invesco India Contra Fund and Kotak India Contra Fund, both, are down 6.04% and 4.14%, respectively, while SBI is up nearly 2.5%.
Historic returns highlight how investing in good stocks that have immense potential to grow but are unable to perform due to external factors. The contrarian market outlook serves best when invested in a bear market to reap the returns in the bull market.
Deepali Sen, founder partner, Srujan Financial Services LLP (a Mutual Fund Distributor) explains to MintGenie the idea and mindset behind parking money in contra funds.
Q. None of the contra funds have performed as per the investors’ expectations. Which reasons do you estimate could be possible for their underperformance?
The DNA of the equity markets is volatility, there are crests and troughs just as there are bull and bear phases. While a growth strategy may work best for the bull runs or momentum-driven markets, a contra strategy could be most worthwhile in bear phases of markets which are witnessing downturns. The last 3-5 years of lag in the performance of contra funds over flexicap/large /large and mid-cap funds was largely owing to markets being in a bull run. Quite a several companies were witnessing all-time highs in their market price. These periods of one-way (largely) market movement works best for growth strategy, not contra investing style.
Q. Why do many personal finance experts advise their clients to add contra funds to their mutual fund portfolios?
A contra fund is supposed to have out-of-favour sectors or a value kind of investing style. The fund manager bets against the prevailing market trends by buying either underperforming or depressed assets then.The idea is that buying equity at a low price(lower than fundamental value)today will be profitable in the long term when the business problem is resolved and the stock will witness a strong rally. Contra funds may not perform in the short term because of the kind of assets they invest in.
A contra strategy serves as a good hedge against market crashes. It hopes to work best after a momentum investing strategy (that aims to capitalize on the continuance of existing trends in the market)is losing its steam.
Q. What are the key factors that we must look into before parking our money in contra funds?
A contra strategy tends to move against the trend of the broad market or has a low or negative correlation to the broader market. A Contra Fund does not chase the momentum of the market or bet on the current favourite. On the contrary, it bets on the opposite – the underdog. Hence, you should consider investing in a Contra Mutual Fund if you have a reasonable risk tolerance, an investment horizon of +7 years, and tons of patience. The key idea is to protect the downside when markets are falling. However, the opposite can also happen, the upside returns could be lower.
Q. Considering how the bearish nature of the market has put tremendous pressure on some stock values, is this the right time to invest in contra funds?
One may not be able to effectively predict the beginning or end of a bull or a bear run, except in hindsight which makes us wiser. And given that ideally our portfolio should be positioned well for every market movement/turn- we should have exposure to growth as well as contra strategy in our portfolio. The best way to buy these strategies is by investing in a staggered way rather than one-time or lumpsum. And at the risk of sounding cliché- time spent in the market is more important than timing it.