Tread with caution when investing in contra funds

Restrict investment in these to 10-15 per cent of your portfolio, say financial advisors

The volatility which has rocked the equity markets over the last year-and-a-half has taken a toll on contra funds as well. These funds, which were supposed to take calls against the reigning market trends, have not been able to deliver returns. Even as most of these are now holding mainstream stocks, their performance is below that of an equity-diversified fund.

For instance, SBI Magnum Contra, the largest of contra funds with assets of Rs 3,204 crore, has invested 40 per cent of its portfolio in bluechips like Reliance Industries, ICICI bank, ONGC, L&T, and HDFC Bank. However, the one-year returns generated are lower than that of the Sensex at -0.79 per cent, largely due to a heavy exposure to risky midcaps.

It is the same story with other contra funds, too. As on June 14, the average one-year returns from contra funds stood at two per cent. In comparison, the Bombay Stock Exchange’s Sensex has given six per cent returns. Regular diversified-equity funds have returned about five per cent in the same period.
  

ON SHAKY GROUND
Scheme	1-year	2-year	3-year
ING Contra Fund - Growth	-0.4467	9.6427	8.8594
Kotak Contra Fund - Growth	-1.256	13.675	9.2621
L&T Contra Fund - Growth	2.6504	8.7288	-0.1648
Religare Contra Fund - Growth	4.4213	20.6971	17.0509
SBI Magnum Sector Funds Umbrella - Contra - Growth	-0.7974	9.6867	7.6915
Tata Contra Fund - Growth	12.5995	22.8119	12.4965
UTI Contra Fund - Growth	-2.61	9.6255	8.9006
Average	2.80	13.55	9.15
*Average of diversified equity schemes (all)	5.19	8.91	16.04
BSE Sensex	5.60	9.61	6.42
Greater than one-year compound annualised returns (in %)   As on June 14, 2011 * As on June 15, 2011                                      Source: www.mutualfundsindia.com

Contra funds invest in stocks with low valuations, but with future potential. This helps them pick the stocks cheap and garner higher returns later. However, their performance depends on factors such as the timing of entry into the stocks, price and concentration.

At times, the general market may take longer to realise the stock’s potential. This means the fund will be saddled with a low value stock for a longer period. “This mismatch can get more pronounced in a volatile market as contra stocks are impacted more than largecap stocks,” says Amar Ranu, senior manager, third party products research, Motilal Oswal Wealth Management .

Besides, there is always the risk of the call going wrong. Says Navneet Munot, chief investment officer, SBI Mutual Fund, “Unfortunately for contra funds, the theme which played out last year was that of 'quality,' which, by its basic nature, comprises stocks recognized by market and trading at a premium. Hence, some of our calls went wrong.”

Mutual fund trackers say most contra funds are deviating from their investment philosophy. For instance, L&T Contra Fund, which invested 22.45 per cent in largecap stocks in May 2008, increased it to 62.34 per cent in April 2011. It was the same with Kotak Contra Fund and Religare Contra Fund, which increased their allocations to largecap funds. SBI contra, UTI contra and ING contra funds have maintained their largecap allocations since 2008.

However, you need to consider long-term performances of the funds before actually moving out. If one considers three-year returns, six of these seven funds have outperformed broader indices like BSE 500 and BSE 100. It’s a mixed story for five-year returns, with three funds beating the broader indices and three trailing them.

According to Hemant Rustagi, CEO, Wiseinvest Advisors, “Those looking to invest in contra or other specialty funds, should do so only after having invested in regular equity diversified funds.”

Even so, they are advised to restrict their investments to 10-15 per cent of their portfolio.