A contrarian fund is a type of mutual fund following a contrarian investment strategy. Such funds will invest in stocks believed to be temporarily undervalued or out of favour, expecting that the market will one day recognise their true value. Contra fund managers are known for going against the prevailing market sentiment, buying what others are selling and selling what others are buying. This strategy requires a great understanding of market trends, patience, and the ability to identify long-term growth potential.

What Contrarian Means in Investment Strategy

The contrarian investment strategy suggests adopting positions opposite to those being held by the crowd. Contrarians assume that the majority of investors tend to act on emotion – fear and greed – rather than applying rational analysis. Consequently, they argue that the market tends to overreact in extremes, both in the positive and negative directions, thereby creating opportunities to benefit through mispriced assets.

How Contra Funds Work

Contra funds work by selecting stocks that are undervalued for the time being or have been neglected by the wider market. Such stocks are mostly found in sectors that may be having temporary setbacks or may be perceived as limited growth opportunities in the short run.

Advantages of Contra Funds 

High Potential Returns: Contra funds have the potential for high returns in undervalued stocks once the market behaves rationally for a correction.

Diversification: Since contrarian funds invest across sectors that are presently unfavored, they easily promote diversification of their portfolio. This diversification might help the fund minimize risk against losses by spreading investments across many industries and asset classes.

Buying Stock at Lower Valuation: More so, contrarian funds tend to purchase stocks at a much lower valuation as compared to the market, which gives them somewhere to go when the price rises. This upside can create enormous wealth for investors when the market finally rights itself on behalf of the undervalued assets.

Contrarian Approach in Risk Management: A contrarian view uses fear and pessimism to its advantage, creating a situation that would allow a balance in risk through investment in companies that may have been excessively sold off due to short-term issues. 

Risks of Contra Funds

Delay of Recovery: For a good recovery, however, it differs in that it may take a really long time for the market to realise the truth about the true value of stocks declared by contra funds, and therefore, for a long time, this investment can be trailing others in the market.

Timing Problems: Because contrarian funds depend entirely on market mispricing, they make it very difficult to pinpoint timing. Still, experienced fund managers may face big hurdles predicting when the value of that stock will be unlocked.

Increased Volatility: A lot of times, a higher volatility is expected in short-term periods because contra funds generally invest in stocks in a downturn or in crisis; hence, frequent fluctuations of the fund value occur.

Risk to Value Trap: The risk here arises when some stocks bought by contrarian funds either slide too far down forever or simply fail to become profitable, thereby making permanent losses. Value traps occur when a stock keeps performing poorly despite being fundamentally undervalued. 

Investing in Contra Funds 

A clear understanding of the investment strategy and risks related to it must also be in place before investing in contrarian funds. Investors interested in such funds may invest in them either via mutual fund platforms or via a mutual fund online Demat account opened for them with the help of any broking app. 

Contra Funds Vs Other Mutual Funds

Contra funds differ from traditional mutual funds in that they are willing to invest in stocks that are unpopular or not currently in favor with the broader market. Other mutual funds, such as growth funds or index funds, typically invest in well-established companies or sectors that are expected to grow steadily. Growth funds tend to favor high-potential, high-growth companies, while contra funds focus on those that are undervalued or mispriced.

While growth funds may perform better in bullish market conditions, contra funds tend to outperform when the market corrects itself and undervalued stocks rise in value. In this sense, contra funds offer a counterbalance to other types of funds that focus on established, high-growth companies.

When to Consider Investing in Contra Funds?

Contra funds are best suited for investors having a long investment horizon and a high risk appetite. Thus, these funds may appeal to investors who are willing to have a contrarian view and bet against the market’s short-term trends.

Conclusion

Contra funds offer a contrarian and distinct way of wealth creation by investing in undervalued stocks and those that are presently not great investments.