Contrarian investingIt usually works like this: A trend breaks out, a flood of investments follow that trend; then there is a brief period of time where investors make money of that trend; soon an event damages the sentiment, and that puts a lid on the trend. Then the hunt for the next trend starts. This cycle keeps repeating in equity markets. However, there are some who get on the boat during the storm rather than waiting it out – which is sort of counter-trend. This strategy of picking stressed or beaten down stocks is known as contrarian investing strategy. One important point to note here is that contrarian investing is different form value investing as it isn’t only buying low and selling high, it also means going against prevailing market sentiments.

In fund management space, this strategy can provide handsome returns outperforming the underlying benchmark by a huge margin. This strategy is played out when markets correct and some sectors/stock get hit more than the others. Such beaten down stocks and sectors are not favoured by market at large. These stocks usually trend at lower than long term PE (price-to-earnings multiple) average. A contrarian fund manager would invest in such stocks. Of course, PE is not the only guiding parameter. In case of  banks, Price to Book (PB) ratio is considered; for other sectors different financial ratios are considered.

Data talks

While the above chart is dated, the trend of performance difference is clear.

Currently almost entire asset management industry is betting on financial services stocks. Each portfolio has 10-30% allocation to financial stocks followed by Auto & consumer durables. However ideally, a contra fund would be overweight on beaten down sectors like – Pharma, Telecommunication, Energy, Oil Marketing Companies etc. Some assets of the fund would be invested in popular stocks or popular sectors which will ensure the downside protection.

Invesco India Contra Fund is underweight FMCG, chemicals & communication sectors compared with Nifty 500 TRI. Whereas SBI Contra Fund stands overweight in healthcare and engineering sectors compared to Nifty 500 TRI. Kotak India EQ Contra Fund is underweight financial sector & overweight on technology sector Vs Nifty 100 TRI.

We believe more money can be made by investing in undervalued or stressed stocks as they have historically provided higher return on investment. Two years ago, IT sector was outcast but stocks like L&T Infotech has given superlative returns – from levels of Rs 700 per share in Jan’17 that surged to over Rs 1700 per share.

Another recent example of contra call would be Yes Bank Stock – there have been worries regarding bank’s management team however banks fundamentals were good. The stock price, from the highs of Rs 370-380 per share, went down to Rs 160-170 per share within three months. The stock did a ‘u’ turn from there after the new CEO was appointed recently, and currently this stock is trending at Rs 215 levels. Those fund managers who had purchased shares of Yes Bank at lower levels have already made profits.

Of course, risk here is high, but so is the reward. Here are the key risks to the strategy.

  • Fund Mangers’ likes and dislikes play a major role in stock selection process.
  • Sometimes it may happen that beaten down companies close operations owing to low growth pressure.
  • The way high risk is not beneficial, low risk also poses threats to the overall returns. Some contra funds also seem to be running non-contrarian strategies.

Performance of contra funds

There are three contra funds available for investment. We studied their recent portfolios and performance.

Here are how the results look:

Scheme Name

AUM as on Dec’18 (In crs.)

1 Year return (%)

3 Years return (%)

5 Years return (%)

10 Years return (%)

Invesco India Contra Fund

3083.82

-6.35

16.54

19.69

20.03

Kotak India EQ Contra Fund

659.15

1.88

16.41

14.38

16.61

SBI Contra Fund

1504.74

-16.91

8.65

11.83

13.55

S&P BSE Sensex TRI

5.62

16.03

13.00

16.33

Multi-Cap Category

-6.58

14.60

15.24

Performance of contra funds is not dramatically higher than performance delivered by Sensex or multi cap funds over medium period of up to three years. Over a 5 &10-year period Invesco India Contra fund has outperformed Sensex by ~4-6%.

In terms of portfolio composition, currently all the above funds have higher allocation (in the range of 10-30%) to financial stocks. The portfolios are diversified portfolios with 40-60 stocks, Kotak India EQ Contra Fund has the highest no of stocks (60). Invesco & Kotak seem to be having conservative positioning while SBI contra fund takes on a little aggressive stance.

Here is the market cap wise break-up of the portfolios.

Market Cap

Invesco India Contra Fund

Kotak India EQ Contra Fund

SBI Contra Fund

Index

5.2

Large Cap

70.9

71.8

38.8

Mid Cap

14.3

9.8

15.9

Small Cap

13.1

1.0

30.2

Other

1.7

12.2

15.1

Let’s compare Sharpe Ratio (which is a measure of how much higher returns the fund has given over risk free returns) and volatility Beta (that indicates sensitivity towards market movement) of contra funds to understand which fund has delivered better risk adjusted returns. Therefore, we desire higher Sharpe Ratio (close to 1) & lower volatility i.e. Beta.

Scheme Name

Beta (3yr)

Sharpe Ratio (3yr)

Invesco India Contra Fund

0.84

0.58

Kotak India EQ Contra Fund

0.73

0.68

SBI Contra Fund

0.80

0.19

From Risk Reward Perspective Invesco India Contra Fund looks to be the best fund in this category. SBI Contra Fund is very aggressively positioned but the risk taken is not commensurate to the returns delivered.

Contrarian investing style is a promising tool that can provide savvy investors with significant alpha over long term. However, investors need to take look at the portfolio positioning carefully before investing.

Please note that investors are requested to consult their financial, tax and other advisors before taking any investment decision.

Author
Priyanka Bharati

Priyanka Bharati is a senior personal finance analyst with RupeeIQ. She can be reached on priyanka.bharati@rupeeiq.com