In stock markets, sailing along the tide is perceived to be gratifying, as investing themes /sectors which are in favour, usually aids in accelerating the pace of wealth creation. But this approach to investing often results in buying expensive, especially when the markets are in an uptrend and thus reduces the margin of safety for investing. It is often seen that during the downtrend of the equity markets, the themes which were once favoured, lose their appeal and investments falter.

Thus to add a trait of value investing to the stock picking approach, contra investing was found. You see, under contra investing, the fund manager focuses on investing against the prevailing market trend in assets that are performing poorly, and selling them when they perform well. The approach hubs on identifying neglected stocks that are undervalued today (trading at lower P/E multiple or P/BV), but have a potential of growing in the long-term. Hence broadly if we observe, contra investing is a subset of value investing. But a noteworthy point is that contra investing is far more complex than value investing, as the objective is picking stocks which are dumped by the market (available at a cheap price) in the short-term, but nonetheless have the potential to gain in the long-term when the market recognises its true potential. Hence by doing so, contra investing aims at sailing against the tide by betting on "out of favour" stocks / sectors, in an attempt to gain in the long-term.

Contra investing was much harped upon during the exuberant phase of the Indian equity markets prior to the sub-prime mortgage crisis and even when the market went into a tizzy on the news of U.S. sub-prime mortgage crisis and Lehman Brothers bankruptcy. The Indian mutual witnessed the launch of its first contra funds way back in the year 1999, with the launch of SBI Magnum Contra Fund - Dividend Option (in July 1999), and thereafter we have witnessed several contra funds (including the "growth option" in SBI Magnum Contra Fund) being launched, as other fund houses were enthused by stunning returns delivered by the pioneer - SBI Magnum Contra (Dividend Option). Mutual fund distributors / agents / relationship managers were busy convincing investors in their luring sales pitch to invest in contra funds. But the question is, "have investments in contra funds rewarded well?"
 

Report Card

	6-Mth (%)	1-Yr (%)	3-Yr (%)	3-Yr (%)	Since Incep. (%)	Std. Dev (%)	Sharpe Ratio
Kotak Classic Equity Scheme (G)	5.2	6.3	3.1	18.5	11.3	4.76	-0.10
Religare Invesco Contra Fund (G)	8.0	1.7	1.3	21.8	8.6	5.02	-0.12
SBI Contra Fund-Reg (D)	0.2	-1.7	-2.2	15.5	20.2	5.21	-0.16
UTI Contra Fund (G)	6.6	0.3	-2.7	12.6	3.8	5.75	-0.16
Category Average*	5.0	1.7	-0.1	17.1	11.0	5.18	-0.13
CNX 500 Index	4.5	2.3	0.4	17.9	-	5.45	-0.11
S&P BSE 100	6.0	5.1	1.5	18.3	-	5.36	-0.09
S&P BSE 200	4.9	3.4	0.6	18.4	-	5.39	-0.11
S&P BSE 500	4.7	1.9	-0.1	18.2	-	5.39	-0.12

NAV data is as on Dec 07, 2013. Standard Deviation and Sharpe ratio is calculated over a 3-Yr period. Risk-free rate is assumed to be 7.38%)
*Note1: Category average has been calculated taking the "simple average" of all the funds.
Note2: Returns over 1-year are compounded annualised.
(Source: ACE MF, PersonalFN Research)  

Well, when seen over a 3-year time frame, barring a couple of funds such as Kotak Classic Equity and Religare Invesco Contra, the other two (i.e. SBI Contra and UTI Contra) have not been able to create alpha vis-à-vis their respective benchmark indices nor have been able beat the category average returns. In fact they have eroded investors' wealth thereby turning unrewarding for investors. Over a 5-yr time as well, only Kotak Classic Equity and Religare Invesco Contra have been able to generate alpha and outperform the category average.

Moreover on the volatility front (as depicted by the Standard Deviation gauged over a 3-yr time frame), Kotak Classic Equity and Religare Invesco Contra have encountered average volatility as compared to the other two who have exposed their investors to greater volatility. But for the level of risk taken, none of these funds have been able to generate positive risk-adjusted returns (as denoted by the Sharpe ratio).

It is noteworthy that during the downside on the Indian equity markets in 2008-09, there were about 9 mutual fund schemes which followed this investment mandate, but subsequently many of the mutual fund schemes in this category were merged (to pelt their underperformance), and now only the aforementioned schemes are left in the category of contra funds.

A peep into their portfolio...
Generally to build-up a portfolio, (as mentioned earlier) contra funds invest in stocks / sectors which are "out of favour" and bet against the market trends or favourite stocks in the market, thereby considering stocks which are neglected, dumped and undervalued by the market in the short-term. But a peep into the portfolio reveals that aren't really going against the tide and following a pure contrarian approach. In fact they have been investing in themes / sectors and stocks which have been in favour and have tried to ride along the tide. Nonetheless, they have capitalised on relatively lower valuations of the equity markets in the past to buy stocks for their portfolio.

As per their current portfolio (disclosed as November 30, 2013) most of these funds have skewed their exposure to themes / sectors such as banking & financial services, information technology (IT), consumer non- durables, pharmaceuticals and oil & gas amongst a few others, which have all been in favour since the past few months. Construction, ferrous metals, power, engineering and autos which once occupied place in top-5 sectors in their portfolios; do not occupy place in their top-5 sector holdings today and this depicts the fact that they played the favourites even then, and now as well they are riding along the tide and not adopting a pure contrarian approach to investing although they have an investment mandate to follow.

What should investors in contra funds do?
The failure of contra funds to stick to their investment mandate is a matter of concern to us. Barring a few funds such Kotak Classic and Religare Invesco Contra, the rest have failed to reward their investors. In case of Religare Invesco Contra too while it has done well over a 5-yr time frame, the fund has shown a tendency to be volatile by plunging more during the downside of the Indian equity markets.

PersonalFN believes investors should refrain adding exposure to any contra fund, and exit the ones which are underperforming by taking advantage of the new all-time high scaled by the Indian equity markets. Since contra investing is a subset of value investing and has exhaustive principles to undertake stock picking activity, we believe holding some good value funds instead would do well to your portfolio.

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