What is Contra Fund?
There is a tendency to equate contra funds with value funds. While they do share some of the common characteristics, there is an essential difference between. Value funds focus on buying stocks that are available well below their intrinsic value. Like Buffett said, they look for margin of safety. However, Contra Funds focus on stocks that are currently underperforming but are expected to turnaround in the future to outperform the market.
How Exactly do you Define a Contra Fund?
Contra fund is basically an equity mutual fund. However, the focus out here is on stocks of companies that are underperforming. For example, steel may be underperforming ahead of the bottoming of the steel cycle. But a turnaround in performance is around the corner. It could be a contra stock to buy. Basically contra funds go against the conventional wisdom.
The focus is on equities of companies that are not performing all that well in the short term. When the current problem of performance or perception is resolved in the near future, the stock is expected to be an outperformer. That is what these contra funds bet on. You can even call it a contrarian approach or out-of-the-box approach to investing in equities.
What are The Contra Funds Available in India?
As we said earlier, there is a tendency to equate value funds and contra funds and bucket them under a single category. But that would miss out the essential difference between the two. Hence we shall stick to the AMFI definition of contra funds. Currently, there are just 3 mutual fund houses offering contra funds in India, viz. SBI Contra Fund, Kotak India Contra Fund, and Invesco India Contra Fund.
The table below captures the performance of these 3 contra funds over 3 time periods viz. 1 year, 3 years and 5 years.
| Scheme Name | NAV Direct | Return 1 Year (%) Direct | Return 3 Year (%) Direct | Return 5 Year (%) Direct | Daily AUM (Cr.) |
|---|---|---|---|---|---|
| Invesco India Contra | 84.48 | 33.17 | 19.40 | 20.25 | 8,194.50 |
| Kotak India EQ Contra | 90.71 | 33.81 | 19.29 | 19.76 | 1,173.34 |
| SBI Contra Fund | 210.48 | 54.63 | 24.89 | 18.66 | 3,451.66 |
Data Source: AMFI
As you can see in the case above, the AUM of the contra fund class is less than Rs.13,000 crore so it is quite small. However, the returns have been pretty impressive across all the time periods considered above. However, one oft stated concern for many fund managers is that in India such opportunities are few and far between and hence having a dedicated fund for the same can be a tall order. That possibly explains why there are just 3 contra funds.
How Does an Investor Benefit by Investing in Contra Funds?
For a contra fund manager, the choice of such contra stocks may be limited. However, investors do see some distinct benefits of investing in such contra funds. Here are a few such benefits captured.
- Contra funds tend to adopt a contrarian approach and if well calibrated, such ideas can generate above market returns to the investors. Of course, the risk is always there but the returns may be worth the risk.
- Contra funds focus on companies that are normally overlooked by most analysts and investors. Hence, the research focus is limited and so the impact of institutional trades on this counter would be obviously limited.
- Normally, contra funds buy stocks when they are in a period of underperformance so in such situations the price tends to be low. Hence investors in contra funds indirectly get good bargains on contra stocks.
- IT has been observed that in times of market crashes or prolonged downsides in the market, it is normally the high beta stocks that fall the most. In such cases, the contra funds tend to hold value much better than other classes of funds.
- Most contrarian stocks have a lot of pent-up value in them but such value is not reflected in the stock price due to its apparent problems. When these issues are overcome, normally there is surge in the stock as it plays catch up.
Is There a Secret Mantra to Investing in Contra Funds?
There is no rocket science, but if you want to invest in contra funds and make the most of the opportunity, there are some unwritten rules. Let us look at these unwritten rules.
- If you don’t have patience, contra funds are not for you. Contra stocks typically take time to get out of trouble and start performing. Unless you take a time horizon of 3-4 years, it would be naïve to expect to be able to make money on contra funds.
- Most of the triggers for contra funds are long term in nature. So, don’t try to call the bottom of these funds or try and trade them. You are more likely to lose money. This is not a stock for timing in the market.
- Never panic when you are invested in contra funds. They take longer than many other growth or momentum stocks to show worthwhile results. There could be bad news on such socks and funds even after you invest but panic is not the answer.
The above are some of the risk factors in contra funds. You must keep patience, staying power and conviction. Contra funds have the potential to give solid returns over the longer term, but it is a game of patience and conviction.
How are Contra Funds Taxed in the Hands of the Investors?
The Income Tax act only differentiates between equity funds and non-equity funds. Any fund with more than 65% holdings in equity is classified as an equity fund for tax purposes. Hence a contra fund will be classified as equity for tax purposes. Here is it means in terms tax implications.
- Contra funds gains will be short term if held for less than 1 year and it will be long term if held for more than 1 year.
- In the case of short term capital gains on contra funds, they will be taxed at a concessional tax rate of 15% on the STCG. However, this will be subject to any cess and surcharge applicable from time to time.
- In the case of long term gains on contra funds, the first Rs.1 lakh of gains for the entire equity category will be exempt. Any gains above that will be taxed at a flat rate of 10%, without any indexation benefits.
- Sort term capital losses on contra funds can be set off against long term and short term gains. However, long term capital losses can only set off against long term gains. Such losses can be carried forwards for 8 years if not absorbed fully in current year.
- Dividends on equity funds and debt funds are now treated as other income in the hands of the investor and taxed at the peak applicable incremental rate of tax.
Can You Provide me With a Quick Checklist Before Investing in Contra Funds?
Here is a quick checklist, before you invest in contra funds.
- Ensure that you have risk appetite for contra funds because even within the equity funds category, their risk is much higher than diversified equity funds or large cap funds. Contra funds are higher on the risk scale.
- Do you have the staying power. Investing in contra funds and expecting wonders to happen in 1 year is not the answer. Keep a time horizon of 5-7 years to actually get the full benefit of these contra funds. With short time frame, you come under pressure.
- Returns tend to be back-ended so when you are planning your goals against contra funds, keep that in mind. Don’t get too aggressive on your expectations from contra funds. Nothing will happen immediately.
- Try to use the Systematic Investment Plan (SIP) approach due to the higher risk quotient. At least, the spreading of purchases will ensure that your cost of acquisition of these contra fund units will be low to begin with.