Contra funds invest in out of favour stocks & should occupy only a small portion of your portfolio
11-Apr-2011 •Research Desk
What is contrarian investing? And should I try it on my own or invest in contra funds instead?
The contra style of investing means that you deliberately don't invest in stocks that are currently popular. You look for stocks that are out of favour with the majority of the investing population. In that sense, momentum investing and contra investing would be polar opposites.
Why would somebody invest in a stock that is out of favour with the market? The first reason is that such stocks are usually available at very cheap valuations. Another reason is that the investor sees value, especially over the long term that most others don't. The company may be having troubles in the short term, but the investor believes that it is fundamentally strong, will overcome its problems, and eventually give him good returns over the long-term.
Take one famous example that illustrates the contra style of investing. American Express was once embroiled in what's known as the salad oil scandal. Around 1962 American Express was into the warehousing business also. An entrepreneur named Anthony De Angelis stored soybean oil in American Express's warehouses. Actually, the oil tanks were filled with water and topped by a thin layer of oil. This inventory somehow passed the inspection of American Express inspectors. Angelis then used the warehouse receipts as collateral to take massive loans. Once the scandal broke, this entrepreneur's company and he both filed for bankruptcy, and American Express was left to foot the bill on the bad loans.
After the scandal American Express's shares tanked. But Warren Buffett believed that American Express's core business remained intact: people still had faith in American Express's traveller cheques. Convinced that American Express would overcome this scandal, Buffett bought 5 per cent of its total outstanding stocks. Though it took several years for the stock to regain its pre-scandal value, it did ultimately recover and paid off Buffett handsomely.
Be warned that the contra style of investing is not easy. Not only do you need in-depth knowledge of the industry and the business, and good research skills, you also need to be an independent thinker. Going against the popular view is never easy. You may also need to keep your position in a particular stock for years (three or more).
Adopt the contra style of investing only if you have a lot of experience in equity investing. Otherwise invest in a contra fund from a mutual fund house.
Moreover, the majority portion of your equity portfolio should be comprised of large-cap, or large and mid-cap funds. A contra fund should comprise only a small portion of your equity portfolio, in order to give it added variety and flavour. All the contra funds that have been rated by Value Research are given in the table above. Invest in one having a good rating and a good long-term track record.