 "Equity MFs stick to their top picks as market trades at historical highs")
Equity-oriented funds continued to witness net inflows for a thirty-third consecutive month in November 2023, though flows declined 22 per cent month-on-month to Rs 15,536.4 crore from Rs 19,957.1 crore in October 2023.
There were six new equity fund launches in November which garnered Rs 1,907 crore. The small and mid-cap category saw the highest inflows at Rs 3,699.2 crore and Rs 2,665.7 crore, respectively. Net inflows seen in the midcap category has been the highest the category has ever witnessed over a monthly period.
"The category which saw the highest uptick in its flows in percentage terms was the value/contra category which received net flows of Rs 1,251.8 crore in November 2023, up from Rs 415.06 crore in the previous month. This could on account of investors choosing to opt for this category given the concerns around valuations in the markets overall," said Melvyn Santarita, Analyst, at Morningstar Investment Research India.
Contra funds are equity mutual funds where the focus 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. Contra funds go against 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," said brokerage IIFL in a note.
Contra funds have performed well in recent years. Currently, there are only three contra funds in India- Invesco India Contra, Kotak India EQ Contra and SBI Contra Fund. Their average return has been 29.5 per cent in the last three years, with SBI contra fund leading with returns of 38.56 per cent.
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In fact, SBI Contra Fund gave the highest return in the category at 27.93 per cent over one year, surpassing the benchmark’s return of 15.71 per cent.
But why would somebody invest in a stock that is out of favour with the market?
As per Value Research, such stocks are usually available at very cheap valuations. Another reason is that the investor sees value, especially over the long term that most others don't. The company may be having troubles in the short term, but the investor believes that it is fundamentally strong, will overcome its problems, and eventually give him good returns over the long term.
" In the current market, scenario where the market has run up so much and most of the stocks are trading at their all-time high, investors are trying to fund opportunities which have not run up yet. Contra fund finds value stocks that are not on the market at the current juncture but have reasonable value with a long-term outlook. So finding cheap in an expensive market is what they try to do. This strategy performs in the cycle and is not consistent but once in a while, they outperform. An investor should invest only a small part of their portfolio in these funds and keep in mind asset allocation," said Mukesh kochar National Head of Wealth at AUM Capital.
"Investors look to invest a part of their portfolio in contra funds when the market is at an all-time high and everything seems overvalued. In November 2023, contra fund portfolios had a 25.62 per cent year-on-year growth as investors sought to find value beyond the market highs," said Ajinkya Kulkarni, Co-Founder and CEO, Wint Wealth.
While the returns earned by contra funds can be very high, the risks are equally high. The ideal investment period for contra funds is three to five years because it takes time for undervalued stocks to recover their value and for contra funds to generate significant returns. Industry body Association of Mutual Funds in India (AMFI) has cautioned that contra funds carry the risk of getting calls wrong as catching a trend before the herd is not possible in every market cycle and these funds typically underperform in a bull market.
Contra mutual funds can be a good option for investors who are willing to take on a higher level of risk in exchange for the potential for optimised returns. The performance of contra funds can be volatile, and there is no guarantee that they will outperform the market over the long term. Additionally, one should also note that contra funds typically have higher expense ratios than other types of mutual funds. Thus, if the fund is not performing in a cycle, your losses will continue to widen over time.
"Retail investors should understand that contra funds bear a higher risk than low-cost index funds. Contra fund managers hypothesise that they can find stocks that will grow in the future. However, the fund generates negative or poor returns if their analysis goes wrong. Thus, retail investors would do better to rely on index funds for long-term wealth creation," said Kulkarni.
