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Friday, February 17, 2006

Mutual funds with a twist

Contra Funds

Diversified equity funds are mutual funds that invest in the shares of various companies in different sectors.

It parts company with other diversified equity funds in the types of stocks it chooses to invest in. As the name suggests, it follows a contrarian view to investing. This means the fund manager will deliberately bypass the popular stocks that everyone else is chasing. Instead, he will invest in companies that are not in fashion.

Why? Because these out-of-fashion stocks would currently be available at a cheap price since they are undervalued.

Contra funds do not invest in just about any stock. The stocks that are selected will be strong on fundamentals but their value is not yet recognised by other investors. They must have the potential to rise substantially over time.

To spot such stocks requires a lot of research and understanding of the industry in question. That is why, if you want to be a contrarian investor, you should consider a contra fund. On your own, you may not be in a position to decide which stocks to go for.

To be a contrarian investor, you must be convinced the stock you choose to invest in has the potential to make it big. You must also have the courage to invest in it when everyone else is ignoring it.

Should you be a contra fund investor?

That depends on where you stand as an investor.

If you have not invested either in stocks or in diversified equity funds, then you should ignore this avenue of investment.

Investing in a contra fund makes sense only if you have already invested in a diversified equity fund and would like to experiment with an alternative investment style.

Secondly, are you willing to take a risk with your investment?

Don't forget, investments in a contra fund are more risky than those in a diversified equity fund.
All said and done, the fund manager is making a call on a company that may or may not eventually do that well and give a phenomenal return. He is taking a substantial risk.

Thirdly, are you willing to ignore this investment for a number of years?

It may take a fair amount of time for the company to start making huge profits and get noticed by other investors. Only when others see its potential and start buying the shares will the price begin to climb upward.

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