The end objective when you choose to invest in mutual funds is quite simple: grow the money. However, the route taken by different mutual funds may vary.
Two types of mutual funds which are quite confusing for an investor are contra funds and value funds. Both these terms sound similar. Both are looking for companies whose stocks are not being fully appreciated in the market today. However, when you scratch the surface a little bit, you’ll realize how different the investment strategies are.
Which one is better suited for you? Well, let’s try and understand the difference in simple terms.
What Is a Value Fund?
The value fund invests in stocks that are currently considered undervalued in the market. A good way of putting this is that the company whose stock this is has a good business. It has good fundamentals, a competitive advantage, or good earnings potential. The problem is that for some reason, the market isn’t giving the company the price it really deserves.
The bet of the fund manager in this case is a pretty straightforward one. The idea is that when other investors and the market realize just how good this company really is, the stock price will go up. And when it does, your money will grow.
Value investing is a well-known strategy that has been championed by many legendary investors over the years.
What Is a Contra Fund?
A contra fund uses what is called a ‘contrarian approach’ to invest its money. It means that the fund manager invests in stocks that are contrary to or against the market sentiment.
These are stocks or sectors that are being ignored or avoided by most investors. Perhaps the company is facing some bad times. Perhaps the entire sector is facing bad times. Most of the market has turned its back on them.
But the contra fund manager is looking at it from a different perspective. He believes that these stocks or sectors have good fundamentals. And when things turn around, which could be months or even years away, these stocks could give good returns.
In short, a contra fund is betting against the market and waiting for the market to turn around.
Key Differences Between Contra and Value Funds
Even though both funds aim to find hidden opportunities, their approaches differ in important ways.
1. Investment Objective
- Contra funds invest in stocks or sectors that are currently underperforming. The expectation is that these beaten-down picks will bounce back and do well in the future.
- Value funds invest in stocks that are currently undervalued — not necessarily underperforming, but simply priced below their true worth.
It’s a subtle but meaningful distinction. A contra fund picks what’s unpopular. A value fund picks what’s underpriced.
2. Why Are These Stocks Trading Low?
The reasons behind the low stock prices differ for each fund type.
- For contra funds, a stock might be underperforming due to economic downturns, political uncertainty, or problems within a specific sector. External factors are often at play.
- For value funds, stocks may be trading below their intrinsic value because of investor biases, market inefficiencies, or simply because the market hasn’t noticed their true potential yet.
3. Risk Profile
Let’s be honest — both types of funds are high-risk investments.
Contra funds are particularly risky because the entire strategy depends on the future expectation that unloved stocks will eventually perform. That recovery might take years, and there’s no guarantee it will happen at all.
Value funds carry high risk too, though the focus on intrinsic value and strong fundamentals can offer a slight cushion.
Either way, both require a strong stomach and a lot of patience.
4. Asset Class
Both contra and value funds belong to the equity asset class.
- A contra fund manager invests in stocks that may currently be giving negative returns. They hold on to these stocks, waiting for the right moment to sell and book profits.
- A value fund manager invests in equity stocks trading below their intrinsic value, expecting the price to correct upwards when the market recognises the company’s true potential.
In both cases, the fund manager plays the waiting game. The difference lies in why they picked those particular stocks.
Similarities Between Contra and Value Funds
Despite their differences, these two fund types share some common ground.
1. Taxation
Since both funds invest in equities, the same tax rules that apply to equity mutual funds are applicable here.
- Dividend income: Any dividends you earn from these funds get added to your total income. You pay tax based on the income tax slab you fall under.
- Short-term capital gains (STCG): If you sell your units within one year of purchase, you pay a flat 15% tax on the gains.
- Long-term capital gains (LTCG): If you hold your units for more than one year and your gains exceed ₹1 lakh, the excess amount is taxed at 10%.
Understanding the tax implications is important because it directly affects your net returns.
2. Investment Horizon
Both funds are designed for the long haul. If you’re looking for quick returns, neither of these is the right fit.
Ideally, you should be comfortable staying invested for at least five years or more. The strategies these funds follow — whether contrarian or value-based — take time to play out. Short-term market movements don’t matter much here. What matters is the long-term trajectory.
So, Which One Should You Choose?
There’s no one-size-fits-all answer here. It depends on your investment style and what you’re comfortable with.
Choose a contra fund if:
- You believe in going against the herd
- You’re willing to invest in currently struggling stocks with the hope of a turnaround
- You have a very long time horizon and high risk tolerance
Choose a value fund if:
- You prefer investing in fundamentally strong companies that are simply underpriced
- You like the idea of buying quality at a discount
- You’re willing to wait for the market to recognise the stock’s true value
Both strategies have merit, and both have delivered strong results for patient investors over the years.
One Important Rule to Know
Here’s something many investors don’t realise. SEBI (Securities and Exchange Board of India) has issued strict guidelines stating that a fund house can offer either a contra fund or a value fund — not both. This rule exists precisely because the two are often confused as the same thing, even though they follow distinctly different investment philosophies.
So when you’re choosing between the two, you’ll likely be comparing funds from different fund houses.
Final Thoughts
Contra funds and value funds may seem similar at first glance. Both types of funds invest in stocks which the market is not appreciating right now. However, the reason for doing so is different in the case of these two types of funds.
Both contra funds and value funds are suitable options for long-term investors who are aware of the risks involved and are willing to wait. Therefore, the right investment strategy should be in line with the investment goal.
Take your time and research the matter well. There is no hurry because the whole idea of both these investment strategies is to wait. Therefore, you may as well start practicing the art of waiting.
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