At a time when equities are down, contra funds have held up better than the benchmark. These funds seek mispriced opportunities in out-of-favour segments, but possess strong long-term earnings potential. Fund houses such as ICICI Prudential, Bandhan and Motilal Oswal have recently launched contra funds that can cash in when cycles reverse.
Contra funds are suitable for those who can stay invested for three to five years and live with long stretches of poor returns. Beginners, or anyone needing steady short-term gains, should stay away. On a trailing three-year CAGR basis, the contra category has averaged around 12% with a median closer to 13.2%. In contrast, the large-cap category has averaged around 9.3% with a median in the same range.
What makes this gap more meaningful is the dispersion within each category. In large-cap, the spread between the best and worst performer is much wider —the highest return is at 13% while the lowest is 6.5%. In contra funds, the range is narrower — lowest return is 9.7% while highest is 13.2% which suggests the contrarian style has benefitted from a structural tailwind.
A key reason for this outperformance is that contra funds have the flexibility to invest across market capitalisations. The mandate allows fund managers to go wherever the contrarian opportunity sits, which is a structural advantage over a large-cap fund that must stay within a defined universe. “When you look at existing contra fund portfolios, they hold a mix of well-known large-caps alongside lesser-followed mid and small-cap names,” says Nirav R Karkera, head of research, W by Groww.
However, on a one-year trailing basis, contra funds are currently sitting at around – 8%, which is in line with large-cap drawdowns. So, in the short term, you get similar pain without the perceived safety of an index-hugging portfolio.
Patience matters
Contra investing needs patience as the market may need years to recognise the value a manager sees in an unfavoured company. A contra manager buys stocks the market dislikes, so the portfolio will often look wrong for a year or two before it looks right. If you check your contra fund every quarter against the Nifty, you will likely exit at the worst time.
“Pick a horizon long enough to cover a full market cycle, and judge the fund against its contra peers rather than just the index,” says Shashank Udupa, founder, Vayu Capital. Where the contra advantage emerges is beyond three years, and it becomes decisive beyond five. The category average at five years is nearly double that of large-cap funds, a sign that the mean-reversion cycle needs time to play out.
“For most investors it works best as a satellite around a diversified core of index or active funds, not a replacement,” says Gurmeet Singh Chawla, managing director, Master Portfolio Services.
Disclaimer: This article is for informational purposes only and should not be construed as investment advice. Investors should assess their financial goals, risk appetite and consult a qualified financial advisor before making investment decisions.
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