Investing against the market

Contrary to perception, investing in contrarian funds does not involve a complex strategy. Yet, these are consistently shunned by investors. To understand why it is so, one must first understand the philosophy behind contrarian investing. It involves buying into companies that are being rejected by most investors because of short-term concerns.

Since these stocks are out of favour, one can buy them cheap relative to their long-term fundamental values. Therefore, the reward-risk balance is quite attractive for investors. "People tend to chase what is popular in the market, which, therefore, is also expensive," says a senior fund manager at Tata Contra Fund, who does not want to be named. The reward-risk proposition is unfavourable if stocks are bought at high valuations.

Take the technology boom in 1999-2000, when tech stocks were in demand. Their valuations were so high that even top performers have not been able to repeat the peak prices of that period. For instance, Wipro today quotes at half its peak price of February 2000 (after factoring in stock splits and bonus issues) despite having performed extremely well over the past 10 years.

Hence, a contrarian approach is advisable whenever the market goes from cheap to fairly valued or is slightly rich in valuations, according to Vetri Subramaniam, Head of Equity Funds at Religare Mutual Fund.

Consider the banking sector during the downturn in 2008, when stock prices of financial companies plummeted. Most contra funds bought banking stocks at the time owing to the strong fundamentals of the Indian banking system and their discounted valuations. Tata Contra bought HDFC Bank, which had been punished by the market because of the sizeable ownership of its shares by foreign institutional investors, or FIIs, during this period. It is currently the top holding in the fund's portfolio.

Religare Contra Fund's exposure to metal companies during the trough last year as well as its overweight stance in real estate through stocks like Phoenix and Mahindra Lifespace enabled the fund to give a superior performance. Now, contra fund managers are bullish on the telecom industry due to the negative view of the sector prevailing in the market following intense competition in this space. Despite the broader market gaining momentum this year, sectors such as telecom continue to be beaten down. This is an opportunity for contrarian investing. In spite of the fact that stocks in this sector are facing selling pressure, they could offer good long-term value, according to Tata Contra's fund manager.

Contrarian Strategies
There are several investment strategies followed by contra fund managers. Religare Contra Fund's Subramaniam specifically looks for companies that have valuable assets or ones that are in a turnaround phase and where the core business is their intrinsic strength. He also looks for absolute and cheap valuations relative to the sector while screening for underperformance, as well as limited public holding relative to the market. Pankaj Gupta, Fund Manager at Magnum Contra Fund, invests in companies whose fundamentals differ from the market perception.

But while these funds prefer to be contrarian, they still end up knitting a portfolio that has large-cap stocks, much like a diversified equity portfolio, says Fahima Shaikh, Research Analyst at India Infoline. Defending this strategy, Subramaniam says the contrarian approach does not only mean going against the market.

"It is supported by a willingness to take on risk early," he says. Tata Tea, for instance, became the top holding of Religare Contra Fund on account of its cheap valuation and limited public holding. Reliance Industries, ONGC and Reliance Infra were added to (or their exposure increased in) the fund due to their underperformance relative to the market.

Similarly, Apollo Hospitals is also a top holding as it is in a sector that has potential for growth but has been underperforming the market for some years, says Subramaniam. Bad news can strike even the bluest of blue-chip companies, says Tata Contra's fund manager. At such times, contra funds buy into companies that have strong fundamentals but are discounted because of short-term performance issues, he adds. So, even though Tata Contra's portfolio has stocks that are blue-chips, they were bought when the stocks were struggling in the market.

Fund managers feel this contrarian strategy always remains relevant and works in all market phases. "This is because we don't buy into broad markets but individual companies, and at any given time, some sectors or companies are out of favour," says the Tata Contra fund manager.

However, the contrarian philosophy may not work well when the market goes from being slightly rich to being extravagantly overpriced in terms of valuations. This explains why contra funds were overlooked during the bull market between 2004 and 2008. In fact, the category manages a meagre Rs 350 crore in assets under management (AUM), which is barely five per cent of the total equity category.

So, should you invest in contra funds? According to Shaikh, one would be better off investing in a basket of blue-chip funds that have a proven track record with strong credentials. Catching a trend before the herd is not possible at every market cycle. However, contra funds expose a part of the portfolio to defensive stocks, which enable them to sail smoothly during the trough, she adds. During the down phase between January 2008 and March 2009, the contra fund category delivered a negative return of 56 per cent, even as the BSE-200 fell 64 per cent.

UTI Contra Fund contained its downside to 45 per cent, while SBI Contra and Kotak Contra fell by 53 and 51 per cent, respectively, during the same phase. While Tata Contra has been the best performing fund in the category, the Religare and ING Contra funds have outperformed the BSE Sensex and the average diversified equity category over the past one year. These funds have done well as far as three-year returns are concerned, too.

On the flip side, this defensive approach makes these funds underperformers during a bull phase. "If an investor is looking to make a quick buck in 3-6 months by investing in momentum stocks, then this is not the fund for him," says the Tata Contra fund manager. In the contrarian theme, one is always trying to get the reward-risk balance in one's favour. So, it is best for investors who have a low-risk appetite and a suitable investment horizon such as the one advised for any diversified equity fund. A fiveyear horizon would be ideal for an equity fund because equity markets can be volatile in the short term. Such a period helps an investor capture the gains from the underlying business growth of a company even if he is caught on the wrong side of volatility.

Also, the risk of the stock calls not panning out is quite high owing to the contrarian strategy that such funds adopt. There are times when a sector or a stock takes long to turn around; there's also the possibility that it never finds favour in the market. For instance, Magnum Contra Fund's high exposure to telecommunication stocks has hurt the fund's performance of late, as have the calls taken within the energy sector, such as on oil marketing companies. So, pick out-of-favour companies with strong fundamentals and you are bound to land some winners in due course. Going against the market is not such a difficult strategy after all.

Courtesy: Money Today