What is it?
The Oxford English dictionary says that the word contra means opposite. Accordingly, in a contra fund, the fund manager’s approach is contrarian, or different than what the rest of the market is doing. This means that unlike other funds, the fund manager picks up stocks that are not in flavour or in vogue, and have been neglected by the market. The fund manager is contrarian with a view to generating a better return than the rest of the market. The idea is to identify stocks that are undervalued and neglected today, but have a high growth potential in the long run. So they expect to buy these stocks cheap since they are neglected in the short run, to reap the benefits later when they become winners in the long run.
For instance, in 2008 when rupee was trading at around Rs39 per dollar, the margins of export-oriented companies in the information technology (IT) sector such as Infosys Technologies Ltd, Tata Consultancy Services Ltd were getting hit. In fact, all IT sector stocks were undervalued and were out of flavour. If a contrarian fund manager had taken a call on investing in the sector at that point and remained invested, he would have been in the money. In October 2010, when the rupee depreciated against the dollar and touched around Rs47 per dollar, the stock prices of these IT companies touched their all-time highs.
What are the risks?
Investing in contra funds comes with a high degree of risk as you are going against market momentum. If the fund manager’s call goes wrong, it may mean prolonged underperformance for the fund in relation to the market.
Also, it may take a fair amount of time for the stock to get noticed by other investors. Only when others see its potential and start buying that the stock prices will begin to climb. So invest only for the long term.
Returns in the past
Since the returns are based on market performance, historically, over three-five years, contra funds have posted average returns of around 12-14% per annum on compounded annual growth rate basis. In the last one year, funds such as Kotak Contra Fund, Tata Contra Fund and Religare Contra Fund have given returns of around 18-20% against Sensex’s gain of 15% in a year. On the other hand, equity diversified funds, as a category, have given 30% average returns over the past 12 months.