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What is contra investing?
Amar Pandit | February 24, 2009 14:27 IST
Last Updated: February 24, 2009 14:42 IST
When equity markets are on the move, investors are quite happy to join the bandwagon. In fact, in boom times, we seldom discuss the strategy being used by our fund manager because all that matters is that he is giving great returns. It's only in a downturn that reality checks are done and one looks at strategies to minimise the pain.
One such strategy is a 'contrarian' investing. As the name suggests, one would expect the fund manager have a completely different strategy to the existing market conditions.
This basic idea is to protect the downside when markets are falling. But the reverse is also true. Returns in an upside might be lower.
Understanding the term 'contrarian' is important because it can be defined in different ways. In most cases, contra investing involves selection of stocks that are not popular at the moment but has the potential to deliver over time because of factors like strong fundamentals, future turnaround in the cycle and so on.
For contra investing, there are couple of strategies that are used. The first one involves direct investment in stocks, whereby a particular theme is identified. The stocks are bought, in accordance with the theme and held for a particular time period. The simpler option is to select a contra fund that is offered by mutual funds.
While investing in this theme, it's important to remember that just because a contra approach is being followed it does not imply that there cannot be a fall in the value of the stock or fund in a downturn.
This is especially true in the current market situation, where bad news after bad news is hitting the market on a day-to-day basis.
That is, in times like this sector may not matter. The fall is all across the board. Only a few stocks have survived this ordeal.
In such times, it is no surprise to find that the contra investment is also witnessing a fall in the value. If one looks at the returns of various contra funds in the market today, all of them have witnessed a negative return over a one-year period ending February 17, 2009. However, there is a difference between the best performing and the worst performing fund. Whereas the former has fallen 36 per cent, the latter has lost over 70 per cent in the same period.
This clearly reflects that there could be a fall in the returns for contra funds when the market is sparing no one.
Another reason for this is that though the fund manager may purchase a stock that is out of favour, the point of entry may not be the lowest one even if they are at historical lows. In that case, the stock would continue to fall for some time.
The most important point of contra investing is that the chances of making money are not immediate. Unlike investment in a bull market, contra investing involves waiting for a long, sometimes painfully long time to get good returns.
Obviously, investors in this theme need to be patient. And there is also a risk that expectations are not met.
But the good part is that when this investment strategy becomes successful, the returns could be extremely high. However, if one looks at the returns of funds in this category and juxtaposes them with returns of equity diversified funds, there is quite a lot of similarity.
For instance, UTI MNC is the best equity diversified fund in the last one year because it has fallen only 30 per cent. In comparison, UTI Contra, the best performing fund in the category has fallen 36 per cent. (See best performing and worst performing funds)
The similarity in returns is because many contra funds end up investing in same kind of themes because of pressure from investors for positive returns. This defeats the 'contrarian' theme.
The contra theme is an interesting one, if one goes by the spirit. However, investors need to look at portfolios more carefully before investing in this theme.
The writer is a certified financial planner.