Contra Funds vs. Value Funds: Choosing the Right Strategy

The basic aim for any mutual fund investor is wealth accumulation. However, various strategies can be used or combined to grow your money over time, depending on your risk appetite, investment horizon, asset allocation needs, and financial goals and objectives.

Two very popular investing strategies involve using two distinct types of mutual funds: Value Funds and Contra Funds. Their purposes and strategies are completely different, and you need to first understand them and then choose your strategy based on your needs. You can choose either strategy or combine the two to suit your needs.

What are Contra and Value Funds?

Let’s understand what these funds are and what their investment strategies are:

1. Contra Funds:
   Contra funds are equity mutual fund schemes with a specific investment objective. These funds go against prevailing market trends, investing in underperforming assets such as shares, bonds, and commodities based on the fund’s mandate. The goal is to capitalise on assets poised for long-term growth due to temporary underperformance influenced by political, economic, or sectoral concerns.
   
   For example, contra funds will go in the opposite direction if the market is bullish on a specific industry. It follows a “contrarian” approach. Contrarian fund managers pick stocks which are usually neglected by most investors but have very strong fundamentals. This way, Contra Funds work as an extremely good hedge strategy in case of a dip or a crash in the market.
   
2. Value Funds:
   Value funds are also equity mutual fund schemes with a specific investment objective. They are often confused with contra funds, which are value funds invested in undervalued stocks with strong intrinsic value.
   
   For example, some stocks are currently undervalued and unimportant, but they have great potential to overperform in the coming years. So, value fund managers select these stocks based on investors’ vision, market gaps, and long-term potential. They check the background of the company’s books, order values, balance sheets, management’s fundamentals, and company philosophy and decide on their stocks for long-term gain.

Differences between Contra and Value Funds:

1. Investment Objective:
   1. Contra Funds: Aim to invest in stocks or sectors that are currently underperforming but are expected to improve in the future.
   2. Value Funds: Focus on stocks currently undervalued but with strong future potential.
2. Underlying Factors:
   1. Contra Funds: Underperformance may stem from economic, political, or sectoral issues.
   2. Value Funds: Stocks may be trading low due to investor ideology, market deficiencies, or similar factors.
3. Risk Profile:
   1. Contra Funds are considered highly risky because their investments are based on future performance expectations, which may take years to materialize.
   2. Value Funds Also fall into the high-risk category, requiring patience and a long-term perspective.
4. Asset Class:
   1. Contra Funds: Belong to the equity asset class, investing in stocks that currently yield negative returns, with the expectation of future value appreciation.
   2. Value Funds: Invest in equity stocks of companies trading below their intrinsic value, with the assumption that prices will correct upwards once the market realises their true potential.

Similarities between Contra and Value Funds:

1. Taxation:
   Both contra and value funds are subject to the same taxation rules as other equity mutual funds:
   1. Dividend Income: Added to overall income and taxed according to the individual’s income slab.
   2. Income from Sale of Units: Taxed as capital gains, with the tax rate depending on the holding period:
      1. Short-term Capital Gains Tax: 20% for holding periods less than one year
      2. Long-term Capital Gains Tax: 12.5% is applicable if holding exceeds one year, with gains over Rs 1.25 lakhs taxed.
2. Investment Horizon:
   Both funds require a long-term investment horizon suitable for investors willing to stay invested for at least five years or more.

Now that we understand their investment strategies let’s understand their performances in the last 5 years to evaluate the two.

Performance Comparison (Last 5 Years) of both

1. Contra Funds:
   1. Maximum return: 30.1%
   2. Average return: 25.48%
   3. Minimum return: 22.68%
      
2. Value Funds:
   1. Maximum return: 27.82%
   2. Average return: 22.81%
   3. Minimum return: 18.05%

Top Performing Contra Funds:

Here is a list of the top-performing Contra Mutual Funds:

1. SBI Contra Fund – Direct Plan-Growth:
   Launched on July 14, 1999, with an AUM of ₹34,317 crore, providing a 31.50% return.
   
2. Kotak India EQ Contra Fund – Direct Plan-Growth:
   Launched on July 27, 2005, with an AUM of ₹3,498 crore, providing a 25.34% return.
   
3. Invesco India Contra Fund – Direct Plan-Growth:
   Launched on April 11, 2007, with an AUM of ₹16,187 crore, providing a 24.13% return.

Top Performing Value Funds:

Here is a list of the top-performing Value Mutual Funds:

1. JM Value Fund – Direct-Growth:
   It was launched on January 1, 2013, with an AUM of ₹832 crore and provides a 29% return.
   
2. Bandhan Sterling Value Fund – Direct Plan-Growth:
   It was launched on March 7, 2008, with an AUM of ₹9,754 crore and provides a 27% return.
   
3. Templeton India Value Fund – Direct-Growth:
   Launched on September 5, 2003, with an AUM of ₹2,137 crore, providing a 27% return.

The best way is to combine both strategies based on your risk appetite and asset allocation and then choose the best strategy for you. However, remember to keep rebalancing your portfolio occasionally to ensure that your investments are working in the same direction as your financial goals.

Conclusion

While historical data showcases the impressive returns of both value and contra funds, including the 25-year-old SBI Contra Fund and newer funds like the Quant Value Fund, an investor must carefully assess their risk appetite, investment objectives, and time horizon. Current trends may not persist, and prudent investment decisions, grounded in patience, perseverance, and conviction, are essential for success in these funds.