Value and contra funds: Add the other if it diversifies your portfolio

Sebi's new rule allows AMCs to offer both value and contra funds with limited portfolio overlap. Here's how the two strategies differ and which investors they suit

Under the Securities and Exchange Board of India’s (Sebi’s) earlier scheme-categorisation framework of October 2017, a fund house could offer either a value fund or a contra (contrarian) fund, not both. Sebi’s February 26, 2026 circular has changed this, allowing asset management companies (AMCs) to offer both funds, provided the portfolio overlap between them is not more than 50 per cent.

 

Value funds’ investment approach 

A value fund invests in stocks that trade below their intrinsic or fair value. Fund managers screen for valuation comfort using metrics such as a low price-to-earnings ratio, a low price-to-book ratio, and a high dividend yield.

Managers hold relatively lower-valuation companies, expecting valuations to mean-revert. “Markets occasionally misprice companies due to short-term concerns, temporary earnings slowdown, etc. Over time, as financials improve, these stocks may re-rate, leading to capital appreciation,” says Piyush Gupta, director, Crisil Intelligence.

 

Contra funds’ investment approach 

As their name suggests, these funds follow a contrarian strategy and invest in stocks or sectors currently out of favour with the market. They invest in areas facing cyclical downturns, temporary regulatory or sectoral challenges, restructuring, or weak near-term sentiment. 

“The contra approach is based on ‘buy when others are selling’, aiming to benefit when market perception changes and neglected stocks recover,” says Gupta.

This style of investing is anchored in behavioural mispricing and cycle reversals. “It takes a contrarian view that prices normalise over the long term once the existing triggers are mitigated,” says Jiral Mehta, senior manager, research, FundsIndia.

 

Value fund: Pros and cons 

The value strategy enables these funds to avoid or reduce exposure to overpriced growth stocks. Buying stocks below intrinsic value provides a margin of safety that reduces downside risk. 

Due to their defensive characteristics, these funds may fall less sharply during market corrections. 

In portfolios tilted heavily towards growth and momentum funds, these funds can provide much-needed style diversification.

 

However, these funds come with their share of risks that investors should be aware of. “They tend to witness prolonged underperformance during bull markets led by growth stocks,” says Gupta. 

Value investing also carries the risk of investing in what are known as value traps — stocks that are valued attractively but have structural weaknesses, due to which their prices may never recover. 

“Sometimes, the search for value can lead to a fund’s portfolio becoming tilted towards specific sectors, creating concentration risk,” says Gupta. And sometimes the stocks that a value fund has invested in may take a long time to recover.

 

Contra fund: Pros and cons 

These funds can benefit from sectoral and cyclical turnarounds, offering higher upside during such phases of recovery or when sentiment shifts sharply. 

“Including them in conventional portfolios filled with large-cap or growth funds can provide diversification,” says Gupta. Investors can use them to take tactical exposure to themes ignored by mainstream investors.

 

These funds too come with their share of risks. Their performance can be volatile until negative sentiment reverses in a sector or company. 

Entering contra stocks at the wrong point can mean that recovery takes a long time. These funds depend heavily on the fund manager's skill, which means they could suffer if the fund manager quits. Like value funds, they also tend to underperform during broad-based bull markets. 

“When the overall market moves only one way, contra opportunities can be low and the contra fund portfolio may start resembling other portfolios,” says Arnav Pandya, founder, Moneyeduschool.

 

Similarities and differences 

These strategies are similar in many ways. Both attempt to monetise market inefficiencies. “Both seek opportunities in undervalued or underappreciated stocks and rely on mispricing correcting over time.

Both require a long-term holding period and can underperform during strong momentum-driven rallies.”

 

But they are also different in many ways. 

“Value funds typically buy fundamentally strong but temporarily mispriced stocks. Contra funds, on the other hand, buy stocks that are unpopular or underperforming at the time of purchase,” says Gupta.

Value funds primarily focus on valuation comfort, whereas contra funds focus on sentiment reversal. Contra funds are more volatile than value funds.

 

When do they outperform 

Value funds typically do well during market recovery or when undervalued sectors start reverting to the mean, and when investor focus pivots from growth to fundamentals. Contra funds perform best when specific out-of-favour themes begin to turn around.

Both these strategies underperform when there is an all-round rally in the market.

 

Value fund: Who should go for it? 

Investors with a long-term horizon and a high level of patience, who understand the concept of buying companies below intrinsic value, and who want to capitalise on undervalued stocks should consider value funds.

“Investors building a factor- or style-based portfolio and having a horizon of seven-plus years may go for these funds, provided they will not bail out when a style underperforms,” says Mehta.

 

At the same time, investors who lack an intuitive understanding of how these funds work could grow frustrated by them because they may underperform even when the overall market is doing well. “Investors seeking quick returns or those with low tolerance for prolonged underperformance should also avoid these funds,” says Abhishek Kumar, Sebi-registered investment adviser and founder, SahajMoney.com.

 

Contra fund: Who should invest 

Contra funds suit aggressive investors who are comfortable betting against the herd and waiting several years for the thesis to play out. 

“Investors who believe the current market trend is unsustainable may go for them,” says Pandya.

 

Investors seeking to build a slightly different portfolio that can provide them with a hedge against a market-like portfolio may invest in these funds. Investors must have high risk tolerance and a long-term horizon. 

Conservative investors or those who prefer following established market momentum should avoid contra funds.

 

Add the other if you own one? 

First, study your own portfolio. If you already own a value fund, add a contra fund (or vice versa) only if it adds diversification to your portfolio. 

“Avoid buying both if it results in duplication of portfolios,” says Kumar. Instead, choose one of these two types of funds that has a better track record and a more consistent philosophy. 

“Focus on execution style and historical performance rather than the label,” says Kumar.