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  • BSE SENSEX
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Contra Funds - All you need to know about them

Contra funds tend to select low-performing stocks and/or sectors at a cheap valuation that are likely to perform well over the long term.

What is Contra Fund

Contra is short of' Contrarian' and Contra Funds are Equity Funds described as mutual funds with a contrary market view. These are an investment plan in which fund managers pick up undervalued stocks instead of investing in equities that look promising, intending to enhance long-term returns for the former. These are not short-term investments and are not the same as value funds.

How Contra Funds are different

Investing in contra funds is often confused with investing in stocks that nobody would ever want to buy.

More often than not, blue-chip firms look out of place in a contra fund that has good business fundamentals. Contra funds only buy the best and most fundamentally sound companies, though, contrary to popular opinion.

Generally, these funds have a list of companies they consider to be fundamentally sound and they are waiting for these companies to either collapse on some company-specific bad news and then purchase those shares.

This could be something like a loss of earnings concerning market expectations, or a business setback that is not permanent.

Contra funds can, therefore, invest in sound companies, depending on the market cycle and the underlying stock value.

How Contra Funds work

Contra Funds invest in shares that the market does not recognize when the fund managers buy them. In the long run, it could see a price-value increase as markets recover. Contrarians believe that exuberant stock demand or no stock demand leads to market mispricing and imbalance. Investors have a herd mentality of buying such trendy stocks which make it overpriced. Therefore, Contra Fund managers are going against the tide instead of buying those shares. They foresee a fall in overpriced resources and then, at the time of their value realization, they will capitalize on it by earning beautiful returns for the poor performing stocks purchased.

Returns on Contra Fund

If the stocks have the potential for growth, contra funds can yield high returns. Contra Funds are an asset in the long term. When markets stabilize, fund investors benefit from increasing share prices, particularly superlative returns can be received because stocks are purchased at a lower cost than the basic value. Experts suggest that mutual funds should be allocated at least 25 percent of the investment.

Risks involved in Contra Funds

There is a related threat of' price trap' in which funds will tend to drift down, believing to have a good value choice in the future. Funds that have been underperforming in bearish markets those remain so in bullish markets and may not expand even if all other stocks perform well. The underlying assumption that assets will reach their real value, in this case, may be wrong. Investing in Contra Funds, therefore, requires a lot of research and analysis. If the market goes down, though, it is less volatile and there is a smaller risk than the overall market because investors have already been out of favor.

Taxation on Contra Funds

There is a related threat of' price trap' in which funds will tend to drift down, believing to have a good value choice in the future. Funds that have been underperforming in bearish markets those remain so in bullish markets and may not expand even if all other stocks perform well. The underlying assumption that assets will reach their real value, in this case, may be wrong. Investing in Contra Funds, therefore, requires a lot of research and analysis. If the market goes down, though, it is less volatile and there is a smaller risk than the overall market because investors have already been out of favor.

Last Words

In comparison to equity-diversified funds, you cannot base your investment decisions on contra-fund returns. You need to look at the fund's mission and the themes in which it invests. If you agree with the outlook of the fund manager, given the expected returns, you should invest. The other thumb-rule is investing in long-standing investments, not in new fund offers.

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