Contra funds follow a unique style of investing; instead of chasing today’s winners, they deliberately pick underperforming or undervalued stocks that most investors are avoiding. The idea is simple: what’s neglected today could turn into tomorrow’s opportunity when the market corrects its pessimism.
While this approach has the potential to deliver attractive long-term gains, it isn’t a smooth ride. Contra strategies often demand patience, discipline, and a strong stomach for periods of underperformance. Before jumping in, you should clearly understand the risks involved.
Here’s what you must know before you invest.
What Makes Contra Funds Different and Riskier?
Most equity funds broadly fall into categories like growth funds, i.e., buying companies expected to expand earnings rapidly, or value funds, i.e., buying companies trading below intrinsic worth. Contra funds add another layer: they buy stocks that are struggling right now, betting that they will eventually recover.
In other words, while a value fund might buy a fairly priced stock in an out-of-favour industry, a contra fund deliberately hunts for sectors everyone else has written off. It thrives on market pessimism.
The risky part? Markets can take a very long time to agree with the contrarian view. During that waiting period, your portfolio may look like it’s stuck in quicksand. For example, SBI Contra Fund has historically invested in sectors the market was avoiding, betting on their eventual recovery. That approach can pay off, but only for those with patience.
Key Risks in Contra Funds
- Longer Gestation Period for Returns
Contra investments rarely turn around overnight. Sometimes it takes years before an out-of-favour sector bounces back. Imagine investing in an airline stock during a downturn; it could be two, three, or even five years before the recovery shows up in your returns. If you expect quick results, this waiting game can test your nerves.
- High Possibility of Prolonged Underperformance
Because contra funds deliberately swim against market sentiment, it’s not unusual for them to lag behind benchmarks for extended periods. If the broader market is riding a technology boom and your contra fund is parked in old-economy sectors, you might spend years watching your returns trail the index. For impatient investors, that’s a recipe for frustration.
- Market Timing Risk
Contrarian calls depend heavily on timing. Buying too early means your fund sits in the red for a long while. Buying too late, and the recovery story is already priced in. Unlike index funds that move with the market, a mistimed entry into a contra fund can magnify your losses.
- Sector & Stock Concentration Risk
- Contra funds often load up on beaten-down sectors. That concentration creates risk: if those sectors fail to recover, the losses deepen. For instance, if a fund goes heavy on metal stocks expecting a revival, and the revival never arrives, the portfolio suffers disproportionately.
- Behavioural Risk (Investor Patience)
This might be the biggest risk of all, not the market, but your behaviour. Investors often lose patience when their contra fund lags, exiting early and locking in losses. Contra investing demands conviction and discipline. If you’re quick to panic, this style might backfire.
- Fund Manager Skill Dependency
Contra investing isn’t about luck. It needs deep research, sharp judgment, and the courage to stay the course. The risk rises if the fund manager misjudges fundamentals or overestimates a turnaround story. In such cases, your portfolio could end up holding duds for far too long.
- Higher Volatility
Stocks in underperforming sectors often swing more wildly than the rest of the market. As a result, contra funds can experience sharper ups and downs. If you’re uncomfortable with roller-coaster rides, these funds can make you queasy.
How to Manage These Risks?
If you are intrigued, the good news is that there are ways to manage the risks.
- Have a long-term horizon (5 to 7 years or more): Contra strategies need time to prove themselves.
- Invest via SIP: Systematic investments average out costs and reduce the pain of mistiming.
- Limit allocation: Keep contra funds to around 5 to 10% of your portfolio. Think of them as a spice, not the main dish.
- Track fund strategy and performance: Review whether the fund is sticking to its contrarian approach and how it fares relative to peers.
- Choose experienced fund managers: Skill and conviction matter a lot here, so pick funds led by proven managers.
Who Should Avoid Contra Funds?
Contra funds aren’t meant for everyone. You may want to avoid them if you:
- Have a short-term investment horizon.
- Want stable, predictable returns.
- Are uncomfortable with volatility or prolonged underperformance.
If the very thought of your fund underperforming for three straight years makes you anxious, contra funds are probably not your cup of tea
Final Thoughts
Think of contra funds as the rebels of the mutual fund universe. They don’t follow the crowd; they challenge it. That spirit can deliver handsome rewards to investors who stay patient and disciplined. But the road is far from smooth.
If you decide to invest, do it with open eyes and a strong stomach. Limit your exposure, give it time, and don’t let impatience drive your decisions. Remember, contra funds can reward conviction, but they are certainly not for everyone.