Contra funds indulge investing in stocks/companies/themes/sectors that are currently out of favour. Contrarian investing is one such investment approach which has taken its shape over the years.

Under contra investing, the fund manager focuses on investing against the prevailing market trend in investments that are performing poorly, and selling them when they perform well. The approach hubs on identifying neglected stocks that are undervalued today (trading at lower P/E multiple or P/BV), but have a potential of growing in the long-term. Hence broadly, if we observe, contra investing is a subset of value investing.

But a noteworthy point is that contra investing is far more complex than value investing. This is because the objective is to pick stocks that are dumped by the market (available at a cheap price) in the short-term, but have the potential to gain in the long-term when the market recognises the value proposition in a holistic fundamental sense in it.

 

Hence by doing so, contra investing aims at sailing against the tide by betting on "out of favour" stocks/sectors, in an attempt to gain in the long-term.

However, the question remains – has this style of investing created enough wealth for you investors, while you got swayed by the exuberance created by the marketers of contra funds?

The fund manager is interested in stocks that are trading at low fundamental values as compared to their long-term value. The product with the most demand in the market is also expensive, and hence the normal tendency is to chase such stocks. But this risk-reward strategy does not work when stocks are already trading at high valuations. Remember the 1999-2000 technology bubble? The value of technology stocks had scaled such highs, that even after the blowout the top performers have not been able to reach that price level during the upside.

The launch of contra funds...
Contra funds became the talk of the town when they were launched. First, contra fund was launched way back in the year 1999, with the launch of SBI Magnum Contra Fund – Dividend Option, and thereafter we have witnessed several contra funds (including the "growth option" in SBI Magnum Contra Fund) being launched as other fund houses became enthused by the stunning returns delivered by the pioneer - SBI Magnum Contra (Dividend Option).

But later, they lost popularity when fund managers encountered a reality check. JM Contra Fund was merged with JM Multi Strategy Fund with effect from April 1, 2011. Similarly, Tata Contra Fund merged into Tata Equity Opportunities Fund since February 15, 2013, and UTI Service Industries Fund and UTI Contra Fund into a new scheme as UTI Multi Cap Fund w.e.f. August 25, 2014.

Currently, only two funds trade in this category – SBI Contra Fund and Invesco India Contra Fund. Although these funds follow a contrarian approach, they invest in large cap stocks that trade below their intrinsic value.

Portfolio Characteristics and strategy:
Generally, to build a portfolio, (as mentioned earlier) contra funds invest in stocks/sectors that are "out of favour", and bet against market trends or favourite stocks in the market, thereby considering stocks which are neglected, dumped, and undervalued by the market in the short-term.

But are they really taking contrarian bets?

  Top-10 holdings

Name of the Company	Holding Percentage as on July 2016
Infosys Ltd.	6.27
Tata Motors Ltd.	6.20
HDFC Bank Ltd.	5.29
Maruti Suzuki India Ltd.	4.48
LIC Housing Finance Ltd.	4.46
Gujarat State Petronet Ltd.	3.93
Hindustan Petroleum Corporation Ltd.	3.72
Axis Bank Ltd.	3.61
Hero MotoCorp Ltd.	3.20
VIP Industries Ltd.	3.14

(Note: The consolidated portfolio of contra funds disclosed in the chart and table above is as on July 30, 2016
(Source: ACE MF, PersonalFN Research)
But interestingly, an analysis of their portfolio reveals that they aren't purely following a contra style of investing – in fact they have an element of value investing. This is because 80% of their top-10 stocks aren't really the ones that are out of favour or mostly dumped by the market. In fact, they are the market favourites and found in any diversified equity oriented fund following a large cap bias or a value style of investing.

Likewise, sector exposure of contra funds aren't really out of favour. They have capitalised on relatively lower valuations of the equity markets in the past to buy stocks for their portfolio. For instance, the aforementioned chart reveals that most contra funds have taken the opportunity of cheap valuations.
 

How have contra funds sailed across bear and bull phases of the equity market?

Scheme Name	Bear Phase	Bull Phase	Bear Phase	Bull Phase
	08/Feb/11 To 20/Dec/11	20/Dec/11 To 03/Mar/15	03/Mar/15 To 25/Feb/16	25/Feb/16 To 23/Aug/16
Invesco India Contra Fund(G)	-16.14	33.52	-19.89	66.17
SBI Contra Fund-Reg(D)	-19.64	27.16	-20.24	64.63
Category Average of Contra Funds	-17.89	30.34	-20.06	65.40
Category Average of Diversified Equity Funds	-16.63	24.80	-19.49	66.25
S&P BSE 100	-17.77	24.39	-22.90	59.11

(Source: ACE MF, PersonalFN Research)
Contra funds exposure to bluechips, have helped them sail through during turbulent times. Thus, during the bear phase contra funds have contained their downfall compared to benchmark index S&P BSE 100. Nevertheless, when observed against the category average of diversified equity funds, contra funds have proven to be more vulnerable. Having said that, given the risk-return trade-off, during the upswing or the bull phase of the equity market, contra funds have proved to be rewarding as well during some bull phases.

But then the question is: Are contra funds staunchly following a contrarian approach? The failure of contra funds sticking to their investment mandate is a matter of concern for all you investors, who simply get swayed by fancy presentations and the exuberance created by the market intermediaries, pink papers, and business channels.

PersonalFN is of the view that investors should not flock onto mutual fund schemes that merely have fancy names, but do not have a unique portfolio in accordance to their set investment mandate. In our opinion, since contra investing is a subset of value investing and has exhaustive principles to follow stock picking activity, we believe holding some good value funds instead would your portfolio some good. However, select wisely and prefer funds that follow strong investment processes and systems. One needs to have a long-term investment horizon in mind, of at least 5 years. PersonalFN believes that your investment discipline and asset allocation will decide your success in investing.

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