AMFI Registered Mutual Fund Distributor | SEBI registered Investment Adviser
FSM LOGO

                    


titl_l_gif
Research
title_r_gif
Share | Email Print more
The Contrarian Way
September 15, 2009

What is contrarian investing, and what are some of the tools contrarians use to analyse the markets? We examine contrarian investing in more detail.


Author : iFAST Research Team



Untitled Document

What is Contrarian Investing?

Contrarian investing involves making investments decisions that run contrary to the consensus. A contrarian believes that certain crowd behavior (e.g., panic selling) among investors can lead to mispricing in markets, which creates opportunities for profit. By acting contrary to the consensus, contrarians stand to profit when the sentiment turns.

Famous investor, Warren Buffett, sums up the essence of contrarian investing: be fearful when others are greedy and be greedy when others are fearful.

Advantages and Disadvantages of Contrarian Investing

When applied diligently, contrarian investing is very profitable. To understand this better, take a look at the BSE Sensex 30 chart for the last 5 years:

During December 2007, investor sentiment was strongly bullish and the markets were overbought. A contrarian investor with investment holdings may have taken the opportunity to pare down their holdings.

Likewise, the recent credit crisis presented great buying opportunities during October 2008 till March 2009. During this period, many investors sold off fundamentally sound stocks at bargain prices.

The contrarian would have taken the golden opportunity during these periods of panic selling to invest into oversold counters.

An investor who bought into the index during March lows would be sitting on about 70% profits as at September 2009.

 

source: iFAST Compilations

Contrarian investing is not an instinctive reaction in falling markets. While purchases are made during widespread panic, contrarian investing relies on in-depth research to source out greatly mispriced stocks and the foresight to look beyond the short-term volatility.

The disadvantage of contrarian investing is its high volatility. Contrarians must be able to get into a falling market and be prepared to see their investment plunge lower. Similarly, they must also be able to get out of the market while it reaches new highs.

During the recent credit crisis, Bear Stearns declared bankruptcy in March 2008. The chart shows the share price movements 3 years before the bankruptcy of Bear Stearns.

Merely investing against the consensus, without careful fundamental analysis would have resulted in some contrarians investing during the panic sell down months before the bankruptcy. Doing so would have been a poor investment.

Another feature of contrarian investing is the emotional impact of going against consensus. It is far more difficult in practice than in theory to master one’s emotions in the face of overwhelming consensus sentiment. Even experienced investors get lost in the cauldron of emotions working against them.


source: iFAST Compilations

Volatility, a commonly used contrarian indicator

Contrarian investors commonly use volatility indicators to assist in their investment making decision. Volatility indicators are also known as fear indicators; it is well documented that in period of panic selling, volatility usually shoots through the roof. Contrarian investors use these indicators to predict the level of panic in the markets and act accordingly to capitalise on the opportunities to make profits.

In India, the volatility indicator catered for Indian markets is called India VIX and it is based on the Nifty 50 Index option prices.

Performance of FSM recommended contrarian funds against the BSE Sensex 100

In India, some fund managers follow the contrarian style of investing. Investors who are comfortable with contrarian investing could consider buying some of such funds. At Fundsupermart.com India, we recommend the SBI Contra fund and UTI Contra fund. Let’s take a look at how they perform against the benchmark BSE Sensex 100.

Annualized Returns

1 year

3 years

5 years

SBI Contra Fund

17.72%

15.91%

35.61%

UTI Contra Fund*

22.06%

9.14%

-

BSE Sensex 100

7.88%

11.49%

24.13%

*UTI Contra Fund was launched on 26th February 2006(source: iFAST Compilations)

The SBI Contra Fund has outperformed strongly against the benchmark consistently for the past 5 years. The UTI Contra Fund, a recently launched fund, has shown outstanding performance in the recent year.

Apart from performance, investors should also look for funds with low expense ratios to preserve most of the fund’s gains. Let’s take a look at the two funds’ expense ratio:

Fund

Expense Ratio

SBI Contra Fund

1.87%

UTI Contra Fund

1.92%

Both funds do not differ much in expense ratio and the SBI Contra Fund is slightly lower than the UTI Contra Fund.

Conclusion

Contrarian investing is a long-term strategy and is potentially very profitable. If you would like to have some exposure to contrarian investing, you can choose to add the recommended contra funds to your portfolio.


iFAST and/or its content and research team’s licensed representatives may own or have positions in the mutual funds of any of the Asset Management Company mentioned or referred to in the article, and may from time to time add or dispose of, or be materially interested in any such. This article is not to be construed as an offer or solicitation for the subscription, purchase or sale of any mutual fund. No investment decision should be taken without first viewing a mutual fund's offer document/scheme additional information/scheme information document. Any advice herein is made on a general basis and does not take into account the specific investment objectives of the specific person or group of persons. Investors should seek for professional investment, tax, and legal advice before making an investment or any other decision. Past performance and any forecast is not necessarily indicative of the future or likely performance of the mutual fund. The value of mutual funds and the income from them may fall as well as rise. Opinions expressed herein are subject to change without notice. Please read our disclaimer in the website.

 


Comments (0) | Comment on this Article
 (Click on Comments/Comment on this Article to show or hide comments/post a comment)
USEFUL LINKS
Recommended Funds
Recommended Portfolios
Chart Centre
Risk Profiler