Dhirendra Kumar talks about the difference between value and contra funds and how to select these funds
You mentioned in your article that it is good to have an allocation to value and contra funds in a portfolio. How does one go about assessing such a fund, given that they make bets on the stocks whose valuation is low?
- Arun Mohan
Value and contra funds are little different from each other. However, both the funds are clubbed together as a bigger category in line with what SEBI has done in its classification. In the case of value funds, fund managers tend to look for companies that may be valued lower than their intrinsic value, however, they may possess strong business characteristics or some competitive advantage. If the fund manager believes that a company's worth is Rs 100 and it is currently available at Rs 80, then he/she may buy the same. On the other hand, contra funds select companies that are currently out of favour. If the market is of the view that certain companies are not likely to do well, but the fund manager thinks otherwise, he's taking a contrarian view as he thinks that these stocks are likely to do better for some reasons. This can turn out to be quite rewarding for investors if the fund manager's call turns out to be correct. Similarly, value investors can earn good returns if they are able to spot undervalued businesses. Hence a business worth Rs 100, if bought at Rs 60 or Rs 70, can turn out to be a profitable bet if the market at some point in the future recognises its true value and stock rises to its fair value. This, however, requires patience as markets sometimes just don't seem to move or recognise the true value of a company and the fund manager falls prey to value traps or the contra bids and it proves to be a test for funds and investors.
Nevertheless, I believe that all the segments of the market are cyclical in nature and businesses tend to be in and out of favour. Hence, I feel that some part of your money - be it 10 per cent, 25 per cent or 35 per cent - should be in such funds as well. However, these funds should not be a dominant part of your portfolio, as growth funds still have a far greater promise.
For evaluating these funds, look at the performance of these funds in one complete market cycle, more specifically from one low to another or one rise and fall phase of the market. If the funds have done well, you can go with them.