The basic aim behind every mutual fund investment is to grow wealth. However, there exist different types of funds catering to different investment objectives. Value and contra funds are two such types of mutual funds that follow a different investment rationale. Before knowing the differences between these two, it’s important to understand their meaning and what they stand for.
What Is A Value fund?
Value funds invest in companies’ stocks that may be undervalued but possess a strong intrinsic value. These funds follow the value investment strategy, which includes looking at a company’s business characteristics or some competitive advantage before going ahead. The philosophy behind value funds is that once the market realizes the true worth of the stock, the stock price will increase in the future and generate good returns.
What Is A Contra fund?
Contra funds follow a ‘contrarian’ approach to investing, meaning the fund manager is picking stocks contrary to the popular market sentiment. It is an investment into stocks of companies that are not performing well or underperforming currently, with an expectation that they will perform well in the future. Contra funds pick stocks that are neglected by majority investors but possess strong fundamental characteristics and therefore have the potential to give lucrative returns to the investors in the long run.
Differences Between Value and Contra Funds
The investment objective behind best contra funds is to invest in stocks or sectors that are currently underperforming but hope to do well in the future.
Value funds invest in stocks that are currently undervalued but hold a strong future potential.
Under contra funds, the underlying factors responsible for a stock underperforming may be due to economic, political, or sectoral issues.
Conversely, some of the reasons why stocks chosen under best value funds may be trading low could be due to investor ideology, market deficiencies, or other similar reasons.
Contra funds are known to be highly risky because the investment is based on the future expectation of the stocks performing, which may take many years.
Value funds too fall in the category of high-risk investments.
Both types of funds require a lot of patience and articulation and are meant for long-term investors.
Contra funds belong to the equity asset class, and invest in stocks that may be currently giving negative returns. The fund manager expects these stocks to gain value over time and will hold on to them till the time is favourable to sell them off and realise good profits.
Value funds are investments in equity stocks as well, but into companies that are trading at a price lower than their intrinsic value. The fund manager relies on the assumption that once the prices of these stocks will correct upwards, once the market realises their true potential and hence will stay invested until the time is right to sell and generate returns.
Since both contra and value funds fall in the equity asset class, the taxation rules followed for any other equity mutual fund will apply. There are taxes on:
Dividend income: The income earned from the dividends on these funds gets added to your overall income and will be taxed under the income slab that you fall into.
Income from the sale of units: The income earned from the sale of the units under these funds will be taxed as capital gains tax. It is important to determine the holding period of the units to calculate the tax rate.
Short-term capital gains tax: If the holding period is less than one year, a tax rate of 15% will be levied.
Long-term capital gains tax: If the units are held for a period exceeding one year and if long-term capital gains realised on the sale of units in both contra and value funds exceed Rs 1 lakh.
2. Investment Horizon
Both contra and value funds follow a long-term investment horizon. Investors who are comfortable staying invested for at least five years and more should invest in these funds.
Many times contra and value funds are confused as the same type of funds however they are actually very different in their investment approach. They are so different that SEBI has issued strict guidelines for fund houses. They state that a fund house can offer either a contra fund or a value fund to its investors and not both at the same time.
This blog has written by Quantum AMC. Views expressed are not of Groww.
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