Contrarian investing: A smart strategy to lift your mutual fund returns

Contrarian investing involves picking sectors, strategies and funds that are out of favour. It works when executed well, but carries risks too.

November 04, 2020 / 09:25 AM IST

If you were one of those investors that got into gold funds and international schemes focused on US equities or even pharma stocks over the last couple of years, you would be called a momentum investor. You went with the flow and invested in segments that were already doing well.

But what if someone took a contrarian view of the markets and did not quite rush behind momentum picks.

Sankaran Naren, chief investment officer, ICICI Prudential mutual fund is famous for looking away from crowded investment avenues. He is one of the Indian mutual fund’s most prolific contrarian investors. Towards the end of 2013, his fund house started rolling out closed-end funds as it anticipated a change in government in May 2014. ICICI Pru was one of the few fund houses that rolled out schemes that invested in mid and small-cap stocks during the time, in fact 28 closed-end schemes till 2016. It got the start of the grand equity rally right.

In 2017, just months after demonetisation and the gush of inflows into equities, Naren cautioned investors that though the markets had gone up, earnings weren’t healthy enough.

Many investors prefer to invest in rising markets and hot themes. Fund houses are only too happy to roll out new fund offers. Gold, international equities and pharmaceutical sector are some of these themes in recent times. However, a bit of contrarian thinking can help you in identifying themes that may rally later on.


Look at past returns carefully

Says Naren, “If an asset class has done well over the last ten years, investors should switch out of that asset class and look at entering another asset class that has been out-of-favour for a similar time-frame.”

Such an approach can help you to take profits when your investments in an asset class have seen strong outperformance.

Naren explains that being contrarian means buying low and selling high. “By 2013, real-estate had done extremely well for ten years, and small-cap equity had done badly for seven years. So, to have bought small-cap equity and sold real-estate would have been a contrarian strategy,” he says.

In the current environment, he says a contrarian approach would be to look at PSU, metal, power and special situation stocks. “Several of these have not delivered returns for the last 10-14 years. Even high dividend yield stocks can be considered, as these offer yields higher than the rate at which they are borrowing money,” Naren points out.

He says the Nasdaq index looks overheated as it has done well for the last eight years.

Within ICICI MF’s funds, this contrarian approach is followed in the value discovery fund, as well as the focused equity scheme.

It is quite common to look at past returns of a category or product, and invest accordingly.

“Retail investors prefer investment ideas that are already over-crowded as most funds are flowing there,” says Anup Bhaiya, founder of Money Honey Financial Services.

“When it comes to making fresh investment decisions, investors should be a bit contrarian and avoid relying upon past returns of any particular market segment or sector. For instance, mid-cap funds that did extremely well in 2017 have under-performed for the last two years,” says Amol Joshi, founder of Plan Rupee Investment Services.

In 2017, mid-cap funds gave average returns of 43 per cent, outperforming most categories. However, returns were -12 percent in the next year and a little over two per cent in the following one.

How to spot a contrarian idea?

Look out for sectors and segments that investors are scared to invest in. Take the case of gilt funds. Over the past three-year period. They have given close to nine percent return. But that has largely come due to the fall in interest rates in 2018 and 2019. The 10-year benchmark government security’s yield went up from about 6.3 percent in January 2018 to 8.15 percent in October 2018. Bond prices and interest rates move in opposite direction.

In 2017 when yields were rising, gilt funds gave just two percent return. But in 2018 and 2019, they gave 7 percent and 11 percent return on an average, outperforming most categories, as yields started to cool-off.

Fund managers say that when yields are on the higher side, it is actually the right time for you to build positions in these funds. When yields are low, which is the present case, it is better to avoid or exit gilt funds.  “In a low interest-rate environment, it is better to avoid entering gilt funds. However, when g-sec yields are closer to eight percent, an investor can take position in these funds,” says Marzban Irani, chief investment officer-fixed income, LIC MF.

Contrarian investing can be risky

If someone advises you to invest in credit risk funds right now, it is quite likely that you might shudder at the idea. The winding-up of Franklin Templeton’s debt schemes, which took risky credit calls, must be still fresh in your memory.

However, a contrarian view would be that the yield to maturity (YTM) of these funds is at elevated levels and factors all the potential risks from further credit defaults and rating downgrades.

As mentioned earlier, higher yields can offer investment opportunities. So, a contrarian investor would look for well-managed credit risk funds at this point.

To be sure, credit risk funds may still be risky propositions, as we don’t know with certainty if the worst is over yet.

Contrarian thinking can help you find ideas where chances of value erosion might be limited with the worst already factored in.

Ravi Kumar TV, director, Gaining Ground Investment Services, says that even as investors prefer chasing momentum, they should also have some diversification to schemes that are run with a contrarian approach. "Investors should also look for such schemes that will give them exposure to a different investment style," he says.
Jash Kriplani
first published: Nov 4, 2020 09:25 am

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