Against the wind
Sep 01 2013 , New Delhi
As stock investor, if you think long term and have enough patience to stand the interim shocks, go against the conventional wisdom and try out a few contrarian bets. We tell you how...
For every two analysts on Dalal Street who will warn you to tread cautiously even when stocks are going dirt cheap, there will be a third one who will say the time to buy stocks is now. This third one is called the contrarian.
Sankaran Naren, CIO for equity at ICICI Prudential Mutual Fund, India’s third largest fund house, invokes Baron Rothschild, the 18th century British nobleman and member of the Rothschild banking family, to remind us of an adage: “Buy when there’s blood on the streets, even if the blood is your own.” Rothschild should know, he made a fortune buying in the panic that followed the Battle of Waterloo against Napoleon.
Saurabh Mukherjea, CEO of institutional equities at Ambit Capital, says it is easy to frighten oneself and one’s clients about India by presenting the cyclical downturn as evidence of its structural shortcomings. “However, there is merit and profit in not being a merchant of fear during these times.”
Contrarian positioning in stocks — for that matter anything in life — is about going against conventional wisdom and spotting opportunities when the consensus opinion squarely points at one direction.
A contrarian investor is one who attempts to profit by investing in a manner that goes against a strongly-held belief. For him, the stronger the belief, the better the opportunities to make a killing.
“There is reasonable historical evidence that suggests whenever there has been such a situation, investors have made good profits. It does not mean the market will rally soon. But I can tell you for sure that the stock prices you see today will soon look very cheap when growth returns,” says Naren.
It is not easy for retail investors to go against the wind on the slightest nudge. But if you were to open a fixed deposit for three years to lock up your idle money, stocks would definitely be a better parking slot.
The growth momentum Naren is talking about may not return immediately. But it will surely come back sooner than you think. And stocks, by nature, will start rising even before this momentum begins to show, as economic fundamentals usually trail share prices.
Kaushik Dani, head of equity funds at Peerless Mutual Fund, says a contrarian strategy usually tries to capture the inefficiencies of a market when it is not trading at fair value for a long period and it is polarised.
As recently as in January 2002, January 2003 and January 2009, when all the news that made headlines were negative, there were investors who went against conventional wisdom and made good profits on a long-term basis.
A contrarian investor would typically start by trying to spot the positives that may have got buried in the din of negative news. Take, for instance, the recovery signs in the US, which are at the core of all our worries triggered by the fear of the Fed tapering its quantitative easing programme and a reverse-flow in FII investment from emerging markets.
But the same is working to the benefit of IT companies, which draw the largest shares of their revenues from the US market.
Add to that a weak rupee, and the entire basket of export-focused industries would start looking attractive. Some of these stocks have already started rising quietly, despite the sharp gyrations in the broader market.
A similar trigger is the revival of growth momentum in Europe. Companies like Tata Steel, Tata Motors, HCL Tech and MindTree will make the most of this turnaround.
And then there are themes to play.
Says Gopinath Natrajan, CEO of India Infoline Mutual Fund, “I think there is an opportunity building up in private sector banks and some NBFCs, counters on which the market has reacted very negatively to recent news flow. Though it may be difficult for the central bank to take a dovish tone today, it will be reasonable to assume that growth at some point will start taking priority over inflation and currency stability, benefitting these companies,” he argues.
Another theme to play in this environment is replacement cost, especially in the manufacturing sector, where the cost of setting up plants has gone up substantially. One such sector is cement, where plants are operating at sub-optimal capacity and there is room for both operating and financial leverage to play when demand returns. Telecom is another sector where the market may still not be fully appreciating the impact of revival of pricing power.
However, Natrajan has a word of caution. “The contrarian approach can be fruitful if the views go right, but the investor also needs to be mentally prepared for a bad patch and should invest only with a long-term view as it may take longer than expected for the tide to turn in your favour. We might be sitting on the foothills of a bull market, but it may take two to three years to kick in.”
Ambit’s Mukherjea says it makes sense to stay focused on buying cyclicals as the Indian economy is in the late stages of a cyclical downturn.
“Since defensives, large-cap and growth stocks continue to trade at close-to-record premiums to cyclicals, small-caps, mid-caps and value stocks, respectively, we continue to believe that investors need to focus disproportionately on cyclicals, smallcaps, midcaps and value stocks.” But one should be prudent to focus only on high quality names across market-caps, he adds.
Dani of Peerless Mutual Fund says, “Some sectors that are core to the economy but are constrained by poor macro-economic environment are available at single-digit valuations at the moment. If the capex cycle is rejuvenated and investments are back, then one can see some good long-term opportunities in this space. Also, with the uptick in global recovery, commodities could be a place where one can spot some good investment opportunities.”
According to Naren, three key preconditions to a contrarian bet should include valuation sanity check, avoiding highly leveraged firms and looking for businesses that have good economic fundamentals.
Dani underlines conviction and patience as two key requirements for a contrarian investor. “Conviction plays a key role as contrarian investing happens at a time when it is fancied the least. Patience is very important as the market can defy fundamentals for extended periods of time,” he adds.
There is an entire category of mutual funds that used to play the contrarian theme all the time. Many of these funds have disappeared in the recent product overhaul in the industry. The UTI Contra Fund, one of the oldest among them, was betting on stocks like Exide, Cipla, Hindalco, HUL, India Cements, ITC, L&T, RIL, Siemens, Tata Power, Tata Motors, Tata Steel, Wipro, Dr Reddy’s, Vardhman Textiles, Sterlite, SBI, HPCL, BHEL, Infosys, Zee Entertainment, OBC, ICICI Bank, Union Bank, Maruti, Axis Bank, PNB, Indian Oil, NMDC, PVR, Jaiprakash Associates, Bharti Airtel, Glenmark Pharma and Oberoi Realty as of July end.
SBI Contra Fund, too, had many of these stocks plus Blue Star, Crompton Greaves, Merck, Elgi Equipments, Nestle India, Greaves Cotton, HDFC, Gillette India, Fag Bearings, VST Industries, Titan, Shriram Transport, BPCL, Blue Dart, LIC Housing Finance, TTK Prestige, HDFC Bank, Oil India, Bank of Baroda, Shriram City Union Finance, Wockhardt, Redington India, Jaiprakash Power Ventures, Jubilant Foodworks, Summit Securities, Torrent Power, Info Edge, JSPL, Royal Orchid Hotels, UltraTech Cement and Jaypee Infratech.
At the end of July, Religare Invesco Contra Fund was betting on J&K Bank, IGL, Idea, ING Vysya Bank, Gujarat Pipavav, Greaves Cotton, Great Eastern Shipping, Federal Bank, Eros International, Corporation Bank, Coal India, CBLO,BIL, Bharat Forge, Balrampur Chini, Apollo Hospitals and AIA Engineering, besides some of the stocks mentioned above.