“I’d rather buy something that is relatively depressed than something that is relatively high,” so believes Marc Faber, the famed contrarian investor and publisher of The Gloom, Boom & Doom Report.
No one would disagree with the premise that investing is not rocket science. But at the same time there’s no denying the fact that following the right investment strategy at the right time is a requisite to become a successful investor. In the world of investing where herd behaviour is quite common, there is an investment strategy that dares to take a diametrically opposite view. Known popularly as contrarian investment strategy — investing in direct opposition to the market majority i.e. selling when others are buying and buying when others are selling — this investment philosophy has worked wonders for investors like Faber.
One Size Doesn’t Fit All
The basic premise of contrarian investing is similar to value investing strategy, i.e. investing in out-of-favour but fundamentally strong stocks and sectors that could be undervalued today, but have the potential for growth in the long term. In course of time, these stocks’ valued catches up with their fundamentals, thus becoming attractive picks.
This works opposite to the principle of ‘sailing with the tide’ that could result in buying expensive especially when the market is going up, leaving investors in the lurch when market falls.
“Contrarian approach fulfils the basic concept of investment of ‘buy low and sell high’. Since these stocks are out of flavour, these can be bought at a discounted price relative to their long-term fundamental values. Therefore, the risk-reward balance is quite attractive for investors in a long investment horizon,” Raajeev Chawla, CFP, Fundmitra.com.
The two biggest merits of contra fund is that their reward risk ratio is better than diversified funds in a long term horizon; and in a bear market, a contra fund does not fall as much as a diversified fund.
“The biggest advantage to a contra fund buyer is that this fund would act as a true diversifier in their portfolio. These funds usually have low beta with the broader markets and thus these funds can really hold portfolio value when broader markets show deep corrections,” says Hiren Dhakan-Associate Fund Manager, Bonanza Portfolio.
However, benefits apart, one of the biggest ironies with contra funds is that most of them hardly remain a contra fund throughout their investment cycle.
“It’s seen that funds tend to become tactical in the short term and usually mould their portfolio more towards growth stocks rather than undervalued/value stocks in order to benefit from short-term rallies. So even if one has invested in a contra fund, they are more or less invested into a normal multi-cap fund,” argues Dhakan.
Is Contrarian Investing Rewarding?
On the returns front, contra funds have fared better than the traditional funds but only in the long run where the holding period is more than 5 years. It goes without saying, though, this return comes loaded with risks higher than those in regular diversified funds.
“The stock picking is usually bottom-up style and is a high-risk high-return strategy. At times these stocks may take much longer than expected until they unleash their full potential value. So these funds should be brought only when one is comfortable with the fund’s short term volatility and when one has the patience to stay invested for more than 5 years or even more,” says Dhakan.
Experts, though, say investment in contra funds carries higher risks than regular diversified funds in the short term. Also, since most of the contra funds do not actually follow a pure contrarian approach, they are exposed to great volatility. However, in the long term the returns of a contra fund usually outpaces that of traditional funds. “The investor with a time frame of more than 5 years can look forward for these kind of fund after having a significant exposure in diversified equity portfolio for all the goals,” advises Sumeet Vaid, CEO, Ffreedom financial planners.