Why contra mutual funds could be the smartest move in your portfolio
Investors are often drawn to trends. When the market rallies around a sector, most portfolios quickly mirror that sentiment. However, history shows that herd behaviour does not always lead to the best outcomes. Those who dare to think differently sometimes capture the most meaningful gains. This is where contra funds stand apart.
A contra mutual fund follows a contrarian investment strategy. Rather than chasing popular stocks, these funds focus on undervalued or ignored companies with strong fundamentals. The idea is simple: when the market overreacts or misprices assets, contrarian investing creates room for long-term wealth creation. For investors willing to be patient and strategic, contra funds could be a smart addition to their portfolio.
What are contra funds?
A contra mutual fund invests primarily in companies or sectors currently out of favour in the market. Unlike conventional equity funds that follow momentum, contra funds adopt a contrarian view by looking for opportunities in undervalued spaces.
As per the Securities and Exchange Board of India (SEBI), contra mutual funds must allocate at least 65% of their portfolio to equity and equity-related instruments. This ensures they remain equity-oriented while offering diversification.
The principle is straightforward: while the broader market may overlook certain sectors due to temporary setbacks or negative sentiment, contra funds identify value and invest for the long term. When market sentiment improves, these investments often deliver strong returns.
How does a contra mutual fund work?
The working of a contra fund is rooted in detailed research and disciplined investment. Fund managers follow a structured approach:
- Stock screening
They scan for companies trading below their intrinsic value. These firms usually have strong fundamentals but are temporarily underperforming.
- Contrarian assessment
The team analyses whether the negative sentiment is short-lived or structural. Only those with recovery potential make the cut.
- Portfolio construction
Stocks and sectors with long-term promise are included in the portfolio, offering diversification beyond market favourites.
- Holding period
Patience is critical. These investments are often held until the market recognises their value.
- Exit strategy
Once stocks reach or exceed fair valuation, fund managers book profits and reallocate capital.
For example, certain cyclical industries such as steel or automobiles may go through downturns due to demand fluctuations. A contra fund may invest during these downturns, anticipating recovery. While such investments may underperform in the short-term, they often shine when market cycles turn.
Key advantages of contra funds
Investing in a contra mutual fund provides several benefits, particularly for investors with a long-term horizon.
- Buy low, sell high opportunity
Since contra funds focus on undervalued stocks, they create scope for attractive gains once prices correct upward.
- Portfolio diversification
Most investors hold growth-focused equity funds. Adding a contra fund introduces a differentiated strategy, reducing overall concentration risk.
- Reduced risk of overvaluation
By avoiding market favourites, contra funds steer clear of overvalued stocks that may fall sharply during corrections.
- Professional management
Experienced fund managers with strong analytical expertise guide the investment process. Their research-driven decisions help identify genuine opportunities.
- Ideal for volatile markets
When market sentiment shifts quickly, contra funds often outperform momentum-driven strategies by capitalising on reversals.
Together, these advantages position contra funds as a strategic tool for portfolio resilience and wealth creation.
Who should consider investing in contra funds?
Contra mutual funds are not designed for every investor. They are best suited for those with specific profiles and expectations.
- Long-term investors
Since recovery in undervalued stocks takes time, investors should commit to at least 5–7 years.
- Value-oriented thinkers
Individuals who prioritise fundamentals over short-lived hype will find contra funds appealing.
- Experienced investors
Those who understand market cycles are better prepared for temporary underperformance.
- Diversifiers
Investors who want an alternative strategy within their equity allocation can use contra funds to balance growth-focused holdings.
- Moderate to high-risk takers
While diversified, contra funds still carry market risk. Investors must be comfortable with volatility.
Essentially, contra funds are a good fit for those willing to go against the tide in pursuit of long-term opportunity.
Investment strategies: SIP or lumpsum?
There are two common approaches to investing in a contra mutual fund:
- Lumpsum investment
This works well after a broad market correction. Buying units at a lower Net Asset Value (NAV) allows investors to benefit from recovery as valuations normalise.
- Systematic Investment Plan (SIP)
An SIP is suitable for most investors as it spreads investment across market cycles. Regular contributions reduce timing risks and benefit from rupee cost averaging.
Whichever method is chosen, it is important to align investments with financial goals such as retirement or education. A disciplined approach ensures that contra funds play a strategic role in portfolio growth.
Risks and considerations
While contra funds offer attractive prospects, they also carry inherent risks.
- Market risks
Investments may underperform broader indices, especially during short-term bull runs.
- Patience required
Gains are seldom immediate. A holding horizon of at least 5 years is crucial.
- Delayed recognition
Sometimes undervalued stocks may remain neglected longer than expected, testing investor conviction.
- Risk appetite
Investors must evaluate whether they can tolerate volatility in pursuit of long-term benefits.
Thus, contra funds should complement, not replace, core holdings in equity or balanced funds.
Taxation of contra mutual funds
As equity-oriented funds, contra mutual funds follow the same tax rules as other equity investments in India:
- Short-term capital gains
Profits from units held for less than 12 months are taxed at 20% plus cess.
- Long-term capital gains
Gains above ₹1 lakh in a financial year, from units held for over 12 months, are taxed at 12.5% without indexation.
- Dividend taxation
Dividends received from contra funds are added to an investor’s total income and taxed as per the applicable income tax slab.
Investors should consult a qualified tax advisor to understand how these rules apply to their specific situation.
Ready to explore contra funds for your portfolio?
Contra mutual funds provide investors with an opportunity to step away from the crowd and invest with conviction. By identifying undervalued companies and patiently holding them until recognition returns, these funds can create meaningful long-term wealth.
Contra funds may not suit short-term seekers, but for disciplined investors valuing strategy over momentum, they could be a smart long-term portfolio choice. In an environment where markets are often driven by short-lived sentiment, choosing a contrarian approach could make all the difference.
If you are considering this strategy, working with a reliable investment partner like Ventura can help you evaluate how contra funds align with your long-term goals. Professional guidance also ensures you stay on track throughout your investment journey.
