Rising appeal of contra funds: the contrarian strategy

Equity-oriented funds maintained their streak of positive net inflows for the thirty-third consecutive month in November 2023, despite a 22% month-on-month decline to Rs 15,536.4 crore from October's Rs 19,957.1 crore. The month also witnessed the launch of six new equity funds, accumulating Rs 1,907 crore. Notably, the small and mid-cap categories experienced substantial inflows, reaching Rs 3,699.2 crore and Rs 2,665.7 crore, respectively. The midcap category recorded its highest-ever monthly net inflows.

Melvyn Santarita, Analyst at Morningstar Investment Research India, highlighted the value or the contra category as having the most significant uptick in flows, receiving Rs 1,251.8 crore in November 2023, up from Rs 415.06 crore in the preceding month. Investors may be drawn to this category due to concerns about overall market valuations.

Contra funds, focusing on underperforming stocks, have demonstrated robust performance in recent years. Currently, only three contra funds exist in India - Invesco India Contra, Kotak India EQ Contra, and SBI Contra Fund, with an average return of 29.5% over the last three years. SBI Contra Fund leads with returns of 38.56%, including an impressive 27.93% over the past year, surpassing the benchmark's return of 15.71%.

Investing in stocks out of favour with the market can be justified, as Value Research suggests such stocks often have attractive valuations. Investors recognise long-term value in fundamentally strong companies facing short-term challenges.

Despite the potential for high returns, contra funds entail significant risks. The recommended investment horizon is three to five years, considering the time required for undervalued stocks to recover and generate substantial returns. The Association of Mutual Funds in India (AMFI) warns of the risk of incorrect calls, noting that contra funds typically underperform in bull markets.

For investors willing to embrace higher risk for optimised returns, contra-mutual funds can be a viable option. However, it's essential to acknowledge the potential volatility and absence of guarantees that these funds will consistently outperform the market over the long term. Additionally, contra funds usually carry higher expense ratios, emphasizing the need for careful consideration, as poor performance in a cycle can lead to widening losses over time.