Should you invest in contra mutual funds?

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Mutual fund managers employ a variety of investment strategies to accomplish the scheme’s investment objective. Among these, many investors are attracted to the contrarian investing strategy.

While the risks are substantial under this strategy, it provides investors with the possibility to generate extraordinary rewards. Here, we’ll look into contra mutual funds, which invest in a contrarian fashion, and discuss some key points about these funds.

There are only three funds in the contra category, and the last contra fund was launched in the year 2007. Contra investing as a style is not as popular, and as a result, most retail investors are not aware of contra investing believes experts.

What are contra funds?

The contra funds have a different approach when it comes to investing. The funds invest to gain market advantage. For instance, under this fund, the fund manager purchases stocks at a lower value in the belief that the stock prices will increase in the long term. Here primarily, the underperformed companies are targeted and evaluated whether they will grow in the future or not.

However, there are times when specific sectors are not performing well; during such times, a contra fund invests in stocks of the companies from these sectors and stays invested till the price of those stocks increases.

How are they taxed?

Under section 80C of the Income Tax Act, the dividend earned from contra mutual funds are deductible from your taxable income up to Rs 1.5 lakh per annum.

On short-term capital gains up to 36 months 15% tax has to be paid, whereas only 10% is payable on gains made for more than 36 months. However, tax deducted on capital gain is subject to indexation.

Should you invest?

Contra funds tend to perform better over the long term and are not ideal for short-term investments. Therefore, these funds are only suitable for the products for an investor with a high-risk appetite who is seeking to take advantage of the growth phase.

“The asset under management (AUM) of the Contra Funds increased from Rs 6,607 crores in June 2020 to Rs 10,971 crores in June 2021, a rise of 66% in AUM,” said Juzer Gabajiwala, Director, Ventura Securities.

As mentioned earlier, contra mutual fund invests against the existing market trends and purchases stocks that are not performing well currently is expected to perform well in the future. So, should one invest?

“In the current bull run, where the valuations of stocks have stretched way beyond their historical average, taking a contrarian bet can be a sensible option for the investors. Contra funds can help investors to diversify their portfolios. Still, they should also keep the riskiness of the fund in mind as every stock which is not performing currently will not necessarily perform in the future,” explained Gabajiwala.

However, the fund’s returns have been muted of the funds, except for SBI Contra Fund which has outperformed the BSE 500. The rest 2 funds have delivered index returns and no alpha was generated in three years compounded annual growth rate (CAGR). (See the table)