The term ‘contrarian’, in everyday life, usually signals to do something full of danger or risk. “Herd behaviour” or doing what everyone else is doing has been physiologically ingrained in us right since ancient times when not running with the entire tribe could mean being run over by a rampaging animal.
In the world of investing, though, the ‘contrarian’ way of investing, is a way to actually remove some risk or danger by having a “Margin of Safety” while investing.
What is Contrarian Investing?
Contrarian Investing is a style of investing where an investor goes against popular/current market trends with eyes wide open. In other words, the investor buys and sells in contrast to popular consensus provided he/she thinks that the prevailing sentiment is not accurate.
Contrarian Investors seek to earn high returns by essentially betting against the crowd. They believe widespread optimism about a particular stock, sector or market could mean overstretched valuations or widespread pessimism could mean undervaluation and a buying opportunity.
Is it similar to Value Investing?
Contrarian investing and value investing are similar in the sense that they try and find opportunities to buy stocks which have depressed prices due to a negative popular opinion – providing them with a margin of safety on the price they pay to buy an asset.
The Oracle of Omaha, and one of the greatest investors of our times, Warren Buffet is a value investor so surely there’s something to value/contrarian investing.
What are the characteristics of a Contrarian Investor and how does it benefit him?
When everyone is talking about it, its time to get out
A heuristic technique or thumb rule that a contrarian investor uses is the cocktail party rule i.e If he hears a particular stock or the markets being discussed at a casual engagement, it is a sign that the market/stock is getting overcrowded and it is time to cut positions.
Benefit: Allows him to get out of overvalued stocks before the inevitable correction
- Don’t rely on past performance/star-ratings or “tips”:
Differing from what most people do, the contrarian investor does not rely on past performance or star ratings from mediums/forums like Value Research or Crisil to determine best funds to invest in. According to them, if it were that easy everyone would use the same metrics and no one would have any bad investments.
Benefit: Concentrating on forward-looking factors like Portfolio P/E, P/B Ratios etc. allows him to choose funds that can potentially outperform in the future and not just funds that have done well in the past.
- Buy when everyone is selling or sell when everyone is buying:
Although incredibly tough, the contrarian investor trains himself to be greedy and buys in times of market panic when everyone is cutting positions and sells in times of euphoria when everyone seems to be buying.
Benefits: By making unconventional and unpopular trades, he benefits from low prices when he is buying and from high prices when he is selling.
- What is obvious to him is not obvious to everyone else:
The contrarian investors hold strong investment beliefs which are not widely accepted and he/she is not afraid to take a financial stand based on that.
Benefits: The contrarian investor hopes to benefit from actions that he takes as a result of original insights. For example, buying Pharma companies even while the sector has been going through a multi-year downturn because they believe that at some point the sector will regain pricing power.
Why is it difficult to be a contrarian investor?
Herd Mentality: As mentioned earlier, most people find security in being creatures of the commonplace and follow popular opinion. It requires true grit and mental discipline to go against the tide and be a contrarian thinker.
Group Thinking: It is easier to accept a loss when your peers are sailing in the same boat. However, with contrarian investing there is a possibility your trade could go wrong while everyone else could be in the green.
Short-Term Losses: Contrarian investing involves making unpopular trades and there is a distinct possibility that owing to the popular sentiment, your investment goes against you in the short term. In fact, it is very likely. It is difficult to withstand that and keep having conviction in your investments.
Our Current Contrarian Picks And Why?
ICICI Focused Equity Fund:
Concentrated Portfolio of Value Stocks, has not been a great performer over the last 3 years but should good going forward owing to the undervalued portfolio.
Quantum Long Term Equity Fund:
Underperforms during market upswings but shines when markets are not doing good and is also a top performer over 10 year period.
Head over to Moneyjar to create your portfolio based on the thought process mentioned above.