Understanding Contra and Value Funds: Which one is right for you?

In a world that acts like a herd most of the time and sways investor decisions, contrarian and value investors swim against the tide. They capitalise on inefficiencies and irrational exuberance in the markets by swimming against the tide. Therefore, contrarian and value funds embody that investment spirit; they invest in stocks that are disfavoured by the market.

The Indian mutual fund industry is experiencing unprecedented popularity boosts. The most important milestone reached is AUM, crossing Rs 67.09 trillion as of 2024. Regarding the growth story, funds form a niche area, uniquely offering opportunities for savvy investors.

Contra and value funds, in particular, have attracted significant inflows, with contra funds witnessing a massive 68% increase in AUM over the past year. The fund offers unique opportunities for savvy investors to capitalize on market inefficiencies and generate long-term returns.

Knowing the intricacies of this investment strategy could help unlock opportunities to beat the market and achieve long-term objectives.

How Contra Funds Work?

Contra funds, or contrarian funds, operate using a unique investment strategy that opposes the prevailing market sentiment. 

Contra funds capitalize on market inefficiencies by investing in undervalued stocks that are currently out of favor. Fund managers meticulously analyze market trends and identify stocks that have been unfairly punished by the market.

By conducting in-depth fundamental analysis, they uncover hidden value and invest against the prevailing sentiment. When the market corrects or experiences a downturn, contra funds can seize opportunities to buy quality stocks at discounted prices. As market sentiment improves, these undervalued stocks can rebound, generating significant returns for investors.

Key Points to Remember:

• High-Risk, High-Reward: Contra funds are considered high-risk investments due to their contrarian nature.
• Long-Term Perspective: Successful contrarian investing requires a long-term perspective.
• Experienced Fund Management: A skilled and experienced fund manager is crucial for the success of a contra fund.
• Diversification: A well-diversified portfolio can help mitigate risk.

By going against the crowd and capitalising on market inefficiencies, contra funds offer the potential for significant returns. However, investors should be prepared for volatility and have a strong risk tolerance.

How Value Funds Work?

Value funds operate on a fundamental principle: buying stocks that are undervalued by the market. Here’s a breakdown of how they work:

1. Identifying Undervalued Stocks:
   • Fundamental Analysis: Fund managers rigorously analyse companies’ financial statements, business models, and future prospects.
   • Valuation Metrics: They use various valuation metrics like:
     • Price-to-Earnings (P/E) Ratio: Compares a company’s stock price to its earnings per share. A lower P/E ratio often indicates an undervalued stock.
     • Price-to-Book (P/B) Ratio: This ratio compares a company’s market value to its book value. A lower P/B ratio can suggest undervaluation.
     • Dividend Yield: Measures the annual dividend per share relative to the stock price. A higher dividend yield can be attractive to value investors.
2. Investing in Undervalued Stocks:
   • Once undervalued stocks are identified, the fund manager invests in them, hoping to capitalise on the potential for price appreciation.
   • The fund manager may hold these stocks for a long period, often years, until the market recognises their true value.
3. Realizing Gains:
   • As the market recognises the true value of the undervalued stocks, their prices tend to rise.
   • The fund manager can then sell these stocks at a profit, generating returns for the investors.

Key Points to Remember:

• Long-Term Perspective: Value investing is a long-term strategy. It’s important to have a patient approach and avoid short-term fluctuations.
• Risk Mitigation: While value investing can be less volatile than growth investing, it’s not entirely risk-free. Market conditions can impact the performance of value funds.
• Diversification: Value funds typically invest in a diversified portfolio of stocks to spread risk.

By following a disciplined approach to stock selection and a long-term investment horizon, value funds aim to deliver consistent returns over time.

Comparison of Contra Funds and Value Funds

Feature	Contra Funds	Value Funds
Investment Philosophy	Contrarian	Value Investing
Stock Selection	Out-of-favor or undervalued stocks	Undervalued stocks
Market Timing	Aims to capitalize on market inefficiencies and mispricing	Focuses on long-term value and less on market timing
Risk Profile	Higher risk, higher potential return	Lower risk, lower potential return
Time Horizon	Long-term	Long-term
Manager’s Role	Active management, selecting undervalued stocks	Active management, identifying undervalued stocks
Investment Style	Aggressive	Conservative

Note: Both contra and value funds are long-term investment strategies. While contra funds focus on short-term market inefficiencies, value funds prioritize intrinsic value and long-term growth.

Which Fund is Suitable for You?

A contra fund versus a value fund largely depends on your risk appetite, investment horizon, and financial objectives. If your risk tolerance is high and you can tolerate risks along with volatile markets, then a contra fund will be suitable. However, if you opt for something more conservative, a value fund will be the most suitable option.

Important Considerations

Both funds can be quite lucrative investments for those who know what the opposite entails. Proper research or professional advice from a financial advisor is indispensable before investing in these funds.

• Diversification: This spread of the portfolio over various asset classes like stock, bonds, and several others.
• Seek Professional Advice: Not all mutual funds are investments without risk. Such a fund should be consulted with a financial advisor to understand the risks involved and the possible benefits one could get.
• Periodical Review: It is important to periodically review your investment portfolio vis-à-vis your financial goals and risk tolerance and the necessary adjustments.

Advantages of Contra Fund Investment

Potential for High Returns

Contra funds tend to capitalise on inefficiencies in the market and gravitate toward undervalued stocks. These will deliver considerable returns when market sentiment flips and the stocks come into favour again.

Diversification

• Investing in contra funds can also offer diversification, thereby reducing overall risk.
• Through investing in out-of-favour stocks, investors tend to have a wider exposure to different sectors and industries.

Long-term Investment Horizon

• Contra funds often maintain a long-term horizon.
• This allows fund managers to focus on the fundamental value of stocks and avoid volatility.

Advantages of Value Fund Investment

Advantage	Description
Potential for Long-Term Returns	By identifying undervalued stocks, value funds can generate significant returns over the long term.
Lower Volatility	Value funds often invest in established companies with stable earnings, leading to lower volatility.
Dividend Income	Many value funds invest in dividend-paying companies, providing a regular income stream.
Risk Mitigation	Value funds aim to mitigate risk by focusing on undervalued stocks.
Disciplined Investment Approach	Value fund managers follow a disciplined investment process with a long-term perspective.

However, it’s important to note that value investing is not a guaranteed strategy. Market conditions can change, and there may be periods when value stocks underperform growth stocks.

Performance Comparison: Contra Funds vs. Value Funds

To provide a comprehensive understanding of the performance of contra and value funds, let’s examine the top 5 funds in each category, benchmarked against their respective category indices over 5 years.

Please note: The specific performance figures can fluctuate over time. For the most accurate and up-to-date performance data, it is recommended to consult with a financial advisor or refer to the latest reports from fund houses or financial platforms.

Top 3 Contra Funds (5-Year Performance)

Fund Name	5-Year Return (%)
Kotak India EQ Contra Fund	24.72% p.a.
Invesco India Contra Fund	25.17% p.a.
SBI Contra Fund	31.79% p.a.

Top 3 Value Funds (5-Year Performance)

Fund Name	5-Year Return (%)
JM Value Fund	32.28%
HSBC Value Fund	31.65%
Nippon India Value Fund	30.42%

Conclusion

Both funds are good additions to a well-diversified portfolio for an investor interested in long-term growth and taking higher risks. However, before making an investment decision, it is vital to research, understand the risks involved, and consult with a financial advisor.

Reflecting on your financial objectives, risk appetite, and time horizon, you can decide if contra funds suit your investment portfolio. Past performance is not an indicator of future results. Your risk tolerance and financial goals must be considered before making an investment decision.

The information contained in this article is intended solely for informational purposes and should not be interpreted as legal, tax, or financial advice. PowerUp is not liable for any errors, omissions, or outcomes that may arise from the use of this information, despite the fact that every effort has been made to ensure its accuracy.