An easy guide to Contra Mutual Funds

Looking for a high-risk and potentially high-reward mutual fund scheme? Contra funds may be right for you.
Contra Mutual Funds
4 mins
21 December 2023

Contra funds are a type of equity mutual funds that invest mainly in stocks. These funds follow a contrarian approach to the market. In other words, Contra fund managers go against the current market trends. They look for undervalued stocks that have strong fundamentals yet are not favoured by the market. These stocks are often available at lower prices and therefore contra funds can gain from sharp increases in the prices of these stocks when the market recognises their value.

How to invest in contra funds?

Here are a few steps to follow:

  1. Register online on your preferred mutual fund website or app.
  2. Choose the contra fund you want to invest in.
  3. Click on invest and choose the amount and mode of investment (SIP or lumpsum).
  4. Provide your KYC details (PAN and bank details) and complete your investment.

Who should invest in contra mutual funds?

Contra mutual funds are suitable for:

  • High risk investors: It is suitable for investors with a high-risk appetite since all these funds are underperforming stocks but have the potential to grow over time. Since these funds are based on a possibility, they can be vulnerable and face fluctuations.
  • Long term investors: It is best suited for investors who can invest for the long term. Since it is a fund that looks forward to the future, it can do well for those who remain invested for a long tenure.

Factors to consider before investing in contra funds.

You must consider these factors before you choose the best contra funds for your portfolio:

  1. Tenure of the investment: These funds are estimated to perform well in the future, which means you will have to be invested in this investment for the long term.
  2. Risks: Even the best contra funds come with high volatility. It is known to see frequent price fluctuations. Therefore, do not worry when you notice fluctuations in the price.
  3. Expense ratio: The managing company will levy you with a certain amount of fees and charges to manage the fund effectively. You will have to be aware of these fees to estimate the correct returns you will make.

Risks of investing in contra mutual funds

The major risks associated with the contra funds category are:

  1. They are based on estimations: These funds invest in undervalued stocks , anticipating they will do well in the future.
  2. It is for expert investors: Investors new to the investing environment need more expertise to invest in these stocks; they are most suitable for experienced investors skilled in research and analysis.
  3. It is based on the fund manager’s expertise: The fund manager used to make investment decisions. You may experience losses if the fund underperforms against predictions.

Taxation on contra funds

Contra funds invest in equities and hence , they are taxed like any other equity mutual funds. Investors have to pay taxes on the dividends they receive from mutual funds at their respective slab rates. Short-term capital gains earned on selling fund units are taxed at a rate of 15% irrespective of investors’ income tax slab rate. Long-term capital gains (realised on selling fund units after one year of holding) of up to Rs. 1 Lakh a year are made tax-free. Any gains exceeding this are taxed at 10%, and there is no benefit of indexation provided.

Advantages of contra funds

Here are some advantages of investing in contra funds:

  • Has higher chances of gaining positive returns since selected stocks have sound fundamentals and are purchased at a lower cost.
  • Comes with lower downside risk in comparison to large cap, multi-cap, mid-cap and other equity funds. This is because the stocks in a contra fund trade at discounts relative to their historical valuations.
  • This Contra Fund has a very low minimum investment requirement, making it easy for retail traders to invest.

Thus, contra mutual funds are a great way to invest in undervalued stocks that have the potential to grow over time. However, it is important to consider the risk factors associated with them carefully, and consider your appetite for the same, before investing.

Frequently asked questions

What kind of returns can I earn from contra funds?

Contra funds are equity funds that invest in stocks that are undervalued. They aim to generate higher returns than the benchmark index by buying low and selling high. The returns from contra funds depend on the fund manager’s ability to identify and invest in such stocks, and the market conditions that affect their performance. Contra funds can offer high returns in the long term, but they may also underperform in the short term.

How long do I need to stay invested in a contra fund?

Contra funds are suitable for long-term investors who have a high-risk appetite and a lot of patience. Contra funds invest in stocks that are currently unpopular or ignored by the market and wait for them to increase in value over time. This may take several years, depending on the market cycles and the fund manager’s strategy. Therefore, investors may have to hold their investment in contra funds for at least 5 to 7 years to reap the benefits of this contrarian approach.

Can I redeem a contra fund investment at any time?

Yes, you can redeem a contra fund investment at any time, as they are open-ended schemes that allow investors to buy and sell units daily. However, you should be aware of the exit load and the tax implications of redeeming a contra fund investment.

Are contra funds a safe investment?

Contra funds are not a safe investment, as they involve a high degree of risk and volatility. Contra funds invest in stocks that are of low value, which means they may have low liquidity, poor financial performance, or negative market sentiment. These stocks may take a long time to recover or may never recover at all, resulting in losses.
Contra funds also depend greatly on the fund manager’s ability to identify such stocks, which may not always hit the mark.

Are there any restrictions on asset allocation for contra funds?

Yes, there are some restrictions on asset allocation for contra funds, as per the SEBI guidelines. Contra funds are a type of equity funds, which means they have to invest at least 65% of their assets in equity and equity-related instruments which follow the contrarian investment theme.

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