A primer on contra fund – what they are and the risks involved.
As the name suggests, the contrarian approach involves taking investment decisions against the general market, i.e. when everybody is bearish on markets, the contrarian will turn bullish and vice-versa. Likewise, contra funds endeavor to benefit by going against the market herd by capturing the investment opportunities available when the markets reversal takes place as per their foresight.
Contra funds largely invest in fundamentally sound companies which are overlooked by the majority of investors and are trading at a discount. They believe in staying long in such equities until the herd favors them resulting in an uptrend of the share price. However, they do not offload these out-of-favour equities only because they have turned attractive. Instead they hold on until valuations have turned too high and unrealistic or business fundamentals have deteriorated or a better investment opportunity surfaces. These funds are not market cap biased and invest across the board.
Risk involved in Contra funds
Market timing and identifying a contrarian investment is always tricky. If one mistimed his/her investment he/she could end up losing more than what he/she anticipated. Contra funds are habitually long on their investment irrespective of the state of markets until a reversal in outlook occurs.
Who should invest?
Contra funds are ideal for those clients of yours who…
- are not risk averse
- have deep pockets
- looking to generate that extra return on their investment amount.
- wish to diversify their portfolio by investing in sound, undervalued and ignored investment opportunities with a willing to stay put until he/she gains from the contrarian investment.
Precautionary factors that need to be kept in mind before recommending contra funds
- SIP is the best route of investment.
- Should have reasonable performance across various market cycle
- Expense ratio (lower the better)
- Portfolio should be high on quality and liquidity
