Whether to invest in a contra fund or a value fund is a critical decision that every investor must make. The significance of this question stems from the fact that it determines the investment strategy and justification for any given investment.
Value funds and contra funds are guided by two very different philosophies on a very fundamental level. Value funds look for equities that are cheap based on their price and appraisal, as well as their fundamental attributes. Contra funds, on the other side, look for under-performing stocks and/or sectors with low valuations that are likely to outperform in the long run.
What are Contra Funds, and how do they work?
Investors put their money into stocks that aren’t performing well at the moment. The great majority of investors do not choose these stocks for investment. Contrarian investing implies buying undervalued businesses with solid fundamentals and focusing on underserved industries with great growth potential.
The assets in these funds typically perform badly, causing valuation distortions. A long-term investment duration is what a contra fund aims to capitalize on.
The core theory behind investing in counter funds is that after the short-term worries around it are addressed, the asset will return to its true worth, which is far higher than its current value. The goal is to buy assets for the long term at a lower price than their inherent value.
What are Value Funds and how do they work?
The value investment strategy is followed by value funds, as the name suggests. In this situation, the fund manager often invests in inequities that he or she believes are undervalued in price at the time of investment based on fundamental features and have significant future potential.
The concept of value investing or value funds is founded on the belief that the market has some inefficiencies. As a result, some stocks trade at a discount to their true value for a variety of reasons. Value fund managers and value investors are usually adept at spotting market inefficiencies and possibly discounted stocks.
The idea of such an investment is that if the market corrects inefficiencies in the underlying equities, the value investor stands to benefit from a rise in the stock’s price. Many fund managers and investors agree that value investing is a good idea. The art of spotting inexpensive stocks necessitates a high level of competence as well as years of experience and knowledge.
Contra funds vs Value funds
Contra fund investing is frequently confused with investing in stocks that no one would ever want to buy. Value stocks, on the other hand, are those that have strong business fundamentals, akin to a blue-chip company.
Blue-chip firms with strong financial fundamentals often appear out of place in a contra fund. Contrary to popular belief, however, contra funds also invest in the best and most fundamentally sound companies.
These funds usually have a list of firms they believe are fundamentally sound, and they wait for them to collapse on some company-specific bad news before buying them. It might be something as simple as a profit shortfall compared to market expectations or a temporary company setback. As a result, depending on the stage of the firm and the price of the underlying stock, both value and contra funds can invest in good enterprises.
How to choose between a Contra Fund and Value Fund?
Value and Contra funds aren’t all that dissimilar. However, under SEBI’s classification, both funds are grouped as a larger category. In the case of value funds, fund managers hunt for companies that are priced below their true worth yet have solid business features or a competitive edge. If a fund manager estimates a company is worth Rs 100, and it is now available at Rs 70, he/she may purchase it. Contra funds, on the other hand, invest in companies that are now out of favor.
If the market predicts that particular firms will not perform well, but the fund manager appears to believe otherwise, he is taking a contrarian position because he believes that these equities will perform better for various reasons. If the fund manager’s prediction proves to be correct, this can be quite profitable for investors. Similarly, if value investors can find undervalued businesses, they can make a lot of money.
As a result, a firm worth Rs 100 that is purchased for Rs 60 or Rs 70 can turn out to be a winning venture if the market considers its real value and the stock increases to its fair value at some point in the future.
This, however, necessitates patience because markets don’t always move or recognize a company’s actual worth, and the fund manager can fall prey to value traps or contra bids, putting funds and investors to the test.
Nonetheless, all market categories are cyclical, and companies come in and out of favor. As a result, a percentage of your money – whether 10%, 25%, or 35% – should be invested in such funds as well. These funds should not make up the majority of your portfolio; growth funds still provide significantly more potential.
Look at the performance of these funds throughout one market cycle, specifically from one low to the next or one rise and fall phase of the market, while analyzing them. You can proceed if the funds have performed satisfactorily.
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