Why contra funds make sense in a Bull Run

Contra funds have a new peer to content with - UTI Contra Fund.

The fund launched last month mopped up more than Rs 1,000 crore (Rs 10 billion) making it the largest contra fund till date. Where net assets are concerned, Magnum Contra follows close behind while the rest have a long way to catch up.
 

Fund	Net assets (Rs crore)
Magnum Contra	1,095.25
Tata Contra	502.53
Kotak Contra	366.24
Chola Contra	126.43
ING Vysya A.T.M	125.95

Rs 100 crore = Rs 1 billion.
Data supplied by Value Research.  Net assets are as on March 31, 2006.

A K Sridhar, Chief Investment Officer, UTI AMC, speaks about this new fund, what contrarian investing is all about and why contra funds make sense in a Bull Run.

Why do you think your fund got such a good response?

In fact, we could have got much more. We mopped up around Rs 1,200 crore (Rs 12 billion) from around 270,000 investors across the country.

While marketing this fund during the NFO period, we clearly explained to investors that the full value of contra investing can be unlocked only if an investor stays with the fund for a period of 18 to 24 months, at the least. Of course, being an open-ended fund, investors can always sell their units and book profits anytime.

Due to this, the response was rather muted.

• Contra investors can make it BIG

However, what we found interesting, was that the collection from the retail investor was very high: around 80%. And this came not only from the big cities or capitals but a large amount of the subscription came from small and mid-sized towns and district headquarters.

Don't you think that valuations are too high now leaving no contra picks?

The focus of this fund is to track down the stocks/sectors, which are out of favour. Out-of-favour stocks exist in any market, be it a bull phase or a bear phase. 

However, I think it is more sensible to launch a contra fund during a Bull Run, because the valuations of the broad market are not considered as cheap or attractive during this time.  So it is wiser to consciously look into the contrarian investing approach when the valuation is stretched. 

But I repeat what I said earlier: In this market you cannot expect a short-term upside because valuations are stretched. So investors should be willing to stay invested for at least two years.

Having said that, we can find contra stocks in any market. In any market you will find stocks that are steeply undervalued. Even during the bearish phase of 2001 to mid-2003, when the entire market remain undervalued, there were specific stocks/sectors that were cheaper than the other stocks. 

Does that mean you will lay more emphasis on relative valuation* rather than depend on intrinsic valuation*? (*see below for explanations)

If you look at a stock per se -- that is at intrinsic valuations -- you may not find a cheaply valued one. So one needs to look at the relative valuation and not just the absolute price or valuation. 

It is not wise to rely solely on base valuation at the peak of a Bull Run. One needs to look at both.

If the market PE was much lower, then it would make sense to lay more emphasis on intrinsic valuation. But when market PE goes haywire, relative valuation comes into play.

There is never a market where all stocks within a sector are uniformily and correctly priced. The psychological behaviour of the investors makes a particular stock/sector completely ignored and those stocks/sectors become attractive. And based on this anomaly, a contrarian makes his picks.

At this point in time, it is not easy to find stocks which are cheaply/attractively valued.  But one can always find stocks, which are relatively undervalued. 

What strategy will you employ when making contrarian picks?

We have broadly categorised it into three strategies:

1. We look for companies that have underperformed in the six months, one year, two year time frames -- basically the bottom third.

These will be stocks that are included in the Sensex, Nifty, BSE 100 and BSE 200. We closely look at these stocks and then go for a bottom-up stock picking strategy.

We scout around for any trigger points in the immediate future that will have a positive impact on the stock. We then take a call on whether or not it will outperform the market.

2. Once again we employ the bottom-up strategy for event-based occurrences. Individual stocks may get beaten down due to various company specific factors. This could be due to the occurrence or non-occurrence of an event. 

3. The third strategy differs from the above two in the sense that they are bottom-up, but this is top-down.

Certain sectors could underperform at different points of time. Banking is a case in point. Steel was an underperformer but not any longer. So we then pick on the sector before zeroing in on specific stocks.

We pick stocks that are not weak in terms of management. We may take a business risk but we do not take a corporate governance risk. We will never compromise on the quality of management.

Based on these parameters, we have invested in around 34 stocks in our contra fund. In all of the above stocks, we look for liquidity.   

Are all contra stocks value stocks?

Growth stocks are those with rapidly growing earnings.  Value stocks are those that are being quoted below what the investor believes is its 'fair value' or 'intrinsic worth.' 

The basic philosophy of contrarian investing is to find fundamentally good 'out-of-favour' stocks.  These could be from the universe of value as well as growth stocks. So contra stocks need not necessarily be value stocks. If they are, it is more of a coincidence than a rule.

Value and growth investing are more approaches to an investment -- it reflects what one believes it. It is not really a stock picking strategy. The  contra approach is about stock picking.

Is your contra fund not similar to the Opportunties Fund?

The Opportunities Fund is a sectors specific fund.

I mentioned earlier that we follow three strategies for picking contra stocks. This one goes only by the third -- the top-down strategy where we take an overview of the sector before selecting individual stocks.

The difference being that the Opportunities Fund will be heavy only in a few sectors. So around 90% of the stocks will be from around four sectors. Not in the case of the Contra Fund which will be much more broad based.

* Intrinsic valuation means that the stock's value is judged on its own characteristics. It represents the "true" or "real" value of the stock. Here the balance sheet and annual reports and quarterly earnings will be studied and tools like discounted cash flow will be employed.

In relative valuation the stock will be compared with other stocks in the same industry. So Price Earnings ratio (P/E), Price to Book ratio (P/B) and other such ratios will be used where that of one company is compared with another.

For more on how you can make money in contrarian investing and other fund managers' views on it, read Contra investors can make it BIG!