Contra Funds - Does swimming against the tide really pay?

Contra, as the name suggests, is something that is opposite to popular belief. When we talk of contra in investment terms, we refer to those stocks that are now out of favour of general investors (for any reason), who are getting out of these stocks or overlooking them. Contrarian investors’ find value in these stocks, picking them up at lower prices and making a profit by selling them once the market realises their potential and the share prices increase. 

This is quite like value picking, though with a slight twist, where some bad news about the stock has led to it being hammered down. For example, a few years ago, Ranbaxy was one of the stocks that was in the news for all the wrong reasons – be it for exceptionally high forex losses or the USFDA ban on 30 drugs being manufactured by the company at its plants in Paonta Sahib and Dewas. These developments pulled the stock down by more than 50 per cent, making it good contra buy.

Mutual funds are known to launch schemes based on the discovery and popularity of different investing concepts. Contrarian investing is among the various fads that have been chased by funds so far. Not long ago, contrarian investing caught the attention of fund houses, with many of them launching dedicated contra funds for investors. Currently, there are seven mutual fund schemes that apply this principle of contrarian investing to find such opportunities and create an alpha for their investors. 

Last year (CY 2011) was an exceptional year, where we saw the broader market going down by 25 per cent. In this background, it makes sense to find out how these funds have performed, and more so, how they would perform going forward. After all, isn’t contrarian investing all about earning better returns across all time periods by riding the peaks and troughs and beating the herds in the investment game.

If we look at the last one year’s performance of the seven contra schemes, we do not find any consistency in their performance. On an average, they have beaten their benchmark returns marginally by 0.62 per cent. However, one should not readily jump to the conclusion that these funds tend to perform better than other sectoral or thematic funds. If we scratch the surface, we find a divergence in their performance that got whipsawed on an average. For example, Tata Contra Fund has outperformed its benchmark, S&P CNX 500, by a huge margin of 6.8 per cent in the last one year, whereas UTI Contra Fund has underperformed its benchmark by 4.93 per cent. So, what is the reason for the UTI Contra Fund’s underperformance?

To get the answer, we tried to look into the individual portfolios of these funds. We did not find anything ‘contrarian’ in their holdings, either in terms of the sectors or the companies that they are invested in – the holdings were like those of any other equity diversified fund. For example, Financials took the top spot in the contra funds’ holdings, which also formed part of the top holdings of the majority of equity diversified funds. The next two spots are shared by Technology, Energy and Services. Even if we look at the individual holdings of these funds, there are very few variations in the top ten spots. Except for a few changes, most of them are holding the same set of companies in their portfolios as the equity diversified funds. For instance, ICICI Bank, ITC, Infosys, etc. feature in all the portfolios. 

One may argue that timing, prices and the valuations at the time of entering these stocks makes a difference, as the same stock might be a contra buy when it is trading below its intrinsic value. However, if this is the case, then why have these funds not been able to beat their benchmarks? We believe that these funds are not going to beat the markets on a consistent and conclusive basis going forward too. Investors would do well to consider contra funds carefully before falling for them.