How does contrarian investing work?
Primarily, a contra fund or investor will invest in out-of-favour stocks that may hold promise not yet discovered by the overall market. Their task is to pick stocks that are wrongly shunned by the larger investor community. These may be companies that have sound operations and potential for a turnaround. Vetri Subramaniam, CIO, Religare Mutual Fund , explains: "It involves taking a positive view on a company much ahead of a change in market sentiment and consensus about it." As fund manager for Religare Contra Fund, his primary focus is to identify companies that are in a turnaround situation and those valued cheaply relative to their fundamental value.
Contrarians thus place bets according to what is rational rather than what is in vogue. In the current scenario, for instance, it would involve seeing through the widespread pessimism and picking out stocks whose low valuations do not reflect the true business potential and strength.
Contrarian investing need not be limited to a particular market situation; it can be profitably implemented in any circumstance. In most situations, there will be stocks that are trading at unfair valuations. The market would have either overbought some companies or neglected some it believes are not worth the risk. The contrarian investor has to judge where the broader market is missing the true story.
However, contra investing is not easy. An investor should have the ability to tune out the noise and murmurs coming from the marketplace. You should be able to stand firm in your conviction no matter what others are saying. You will also need to think out of the box to identify the opportunities that others may have missed.
What a contrarian can gain
For a contrarian investor, the payoff can be potentially rewarding. If your bet turns out right, the returns can be very high. This is because you are buying low and could, subsequently, sell high. The contrarian invests in a stock when it has a valuation gap. Gradually, as the market gets wind of the true potential of the company and makes a beeline for it, the stock price will rise.
For instance, Bharti Airtel was a beaten down stock till a year ago (trading at around Rs 250), as the stock market had reacted adversely to the tariff war among mobile operators. Since then the company has exhibited a penchant for growth by expanding its global footprint, launching next generation services and is better placed compared with its peers, riding on its management pedigree. The price has now surged by about 50%, with potential for further upside.
Just like most investors move in herds, fund managers tend to mimic each others' portfolios, thus offering little differentiation. Investors may find a way out of this herd mentality with the help of contra funds. This could be the ideal solution for someone willing to take on greater risk.
The problems of being a contrarian
Contrarian investing can be highly risky. Tarun Sisodia, director, institutional equities, Anand Rathi Securities, cautions: "Contrarian investing is a different philosophy. You should ensure that it fits your risk profile. Also, it should not form a major part of the portfolio." By courting stocks that are ignored by others, you may run the risk of bearing huge losses as the market may have valid reasons for staying away from them.
If your call doesn't work out, your money could go down the drain. For instance, airline stocks have been out of the market's radar for a while now and justifiably so. With rising air turbine fuel prices and heightened competition, most players have been piling on losses with no turnaround in sight. In this scenario, it wouldn't make sense to place faith in airline stocks.
Returns can be also very slow to materialise in this strategy. It is not likely to yield quick returns since a turnaround, if any, can take a lot of time. Patience is a virtue required of any investor, but is especially true for the contrarian.
Performance of contra funds
People who invest in contra funds believe that as they are paying fund managers to take risks and bet against the market, this is exactly what they are getting. Unfortunately, this may not be the case. Some of the contra funds available today are contrarian only in name. They are not pure contra funds because they hold stocks that can be found in any ordinary equity fund's portfolio, making them no different from the rest.
If you are considering investing in a contra fund rather than doing it on your own, check how these funds have fared. SBI Magnum Contra, the first of its kind to be launched in the country, has delivered stellar returns (21.76% compounded annual growth rate) since its inception in 1997.
Tata Contra has performed exceptionally over the past one year (16.4%), while Religare Contra has emerged the top performer over the 3-year period (13.5% CAGR). On the whole, however, contra funds haven't fared well as compared to multi-cap equity funds. In the past year, for instance, contra funds have averaged 5% returns while the broader category has yielded 8%. Over three years, where multi-cap schemes have delivered a CAGR of 7.38%, contra funds have only averaged 6.44%.
Source: www.economictimes.com
Ravi Jhawar
Summer Intern-Technical Analyst
DENIP Consultants Pvt. Ltd.
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