Going against the trend

Contrarian investors share insights on how they play the markets and the pitfalls to be avoided

Some people like to go against the tide. Take contrarian investors, for instance. They buy stocks when others are selling and vice versa.

A contrarian investor tends to buy when the overall market sentiment is negative and the valuation of the market is lower than its intrinsic value. This applies not only to the broader market’s trend but also to individual stocks, commodities and other asset classes such as gold and even real assets.

When the pessimistic sentiment on any asset deepens and its price plummets, then the risks of that particular asset get exaggerated.Finding out such a distressed asset class, sectors or individual stocks, buying them at lower levels and selling when the price recovers is the modus operandi of the contrarian investors. For instance, when the price of gold falls, retail investors play the contra card and buy gold, expecting a recovery.

Value investing and contrarian investing have the same objective of optimising returns. Both watch for undervalued assets that subsequently turn into a money-making one after a particular time period. Both value investing and contrarian investing follow similar parameters before investing.

However, they differ in one factor. Value investing focusses more on the Price Earnings ratio, whereas in contrarian investing, behavioural finance ideas such as how that asset class has done in the past, its peer comparisons, valuation, negative sentiment and external factors affecting the asset class, and so on, are considered.

Karthi J, a part-time trader who has been availing services from Epic Research says, “Contrarian investing is good but it has its own risks since there is no guarantee on returns and the downside can be high.

Also, contra investing requires the skill of being in the market on a full-time basis. I bought some stocks in December 2016 for a very short span of time and with a specified risk.”

When markets were down last November, Satinder Singh, an active trader from Amrapali Aadya Trading & Investments, took a contrarian view and bought the shares of DLF, DHFL, Bajaj Finance, Petronet LNG and SBI.

“When you are taking a contrarian bet, you should look at the company management, the company’s reach in the market and financial ratios very carefully,” he stresses.

In an overheated market, betting against the trend can play out well at times. Investors seeking to take a contrarian bet in the current overheated market can consider a few options.

For instance, investors can look at the defensive sectors such as pharma and software which are currently in the doldrums due to many reasons. Nevertheless, these sectors have delivered excellent returns in past.

But one should have the patience to stay invested for a longer period until the tide turns in their favour. Also, one should keep in mind that these bets are riskier than the normal trend-following investments.

Jegathesan Durairaj, a passionate trader based in Chennai who is also a Star Performance Trader award winner in Zerodha, has been value investing in the cash market for a decade and trading in futures and options for a couple of years. He stays up-to-date with the events in the equity markets.

Jegathesan starts with analysis, then plans the trade and finally executes it systematically and posts the plans every morning in his blog.

“A fundamental change in sector, significant correction, Price to Book Value ratio, PE ratio, dividend yield, technical factors, and the company’s future prospects are some of the parameters to be looked at before taking a contrarian view,” says Jegathesan.

He recalls his past experience and says, “I made a contra investment in the metal sector (Vedanta) and banking (HDFC Bank). During the downtrend, all metal stocks traded below book value but metals are an essential commodity which cannot go valueless. Likewise, banking stocks corrected due to NPA issues. It is well known that, till now, banking services have not fully penetrated in India. I made a good bet in the banking sector and it yielded very decent return. ”

Sandeep Prabhudesai, a graduate from IIM Ahmedabad who started his career in financial markets and became a full-time trader two years ago, says he takes a contrarian view when the markets are in a correction phase.

For instance, when the markets corrected in the last quarter of 2016, he bought Nifty ETFs and stocks like HDFC Bank, RBL Bank and Maruti between November and December 2016.

The Nifty ETF is up about 15 per cent, the Bank Nifty ETF has gained about 21 per cent and the stocks between 25 and 45 per cent.

Go safe on funds

Most traders or investors are unaware of the existence of contra funds. Currently, there are two funds that follow contrarian investing as their investment objective, namely SBI Contra Fund and Invesco India Contra Fund. These schemes follow the mandate of identifying potentially undervalued stocks across sectors and then holding on to them until the underlying theme plays out.

Moreover, these funds have delivered excellent returns, beating their benchmark as well as the broader indices.

Interested investors with a long-term perspective can opt for these funds as a diversification to their portfolio instead of taking high risk and investing directly in equities.

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