Contrarian calls to tide over volatile markets

Have conviction in your bets and use stop-loss as a defence mechanism to curtail losses

In February, the majority of equity investors would have kept away from public sector banks (PSBs), due to uncertainties over their growing non-performing assets (NPAs). The Nifty PSU Bank index consequently fell to its lowest this year and touched 1,968. But, if an investor had taken a contrarian bet on the sector, she would have reaped rich rewards. The index is currently at 2,882.05, up 46 per cent.

This reflects what Warren Buffett once said. “A simple rule dictates my buying: ‘Be fearful when others are greedy, and be greedy when others are fearful’.” Contrarian strategy can yield handsome rewards, if investors select stocks carefully and maintain conviction. Experts say contrarian calls exist in all market conditions, especially in the volatile markets that we are experiencing at present.

Based on present valuations and analysts’ outlook for the next 12 months, four sectors could prove sound contra bets currently.

Pharmaceutical: The bellwethers in this sector have seen their value erode over the past one year, after the US Food and Drug Administration issued warning letters and import alerts, as the plants didn’t comply with the standards set by the regulator. “We are positive on the sector, as the size of the opportunity is large and profitability is good. This space offers a great risk-reward ratio. The regulatory issues should get resolved,” says Prateek Agrawal, chief investment officer, ASK Investment Managers.

Information technology: Stock prices of companies in this sector have taken a beating lately, as investors worry that their business would be affected due to Britain’s exit from the European Union and due to the economic slowdown in Europe. There are also concerns that not many companies will be able to keep up with changing technology. These apprehensions could be overblown. “IT companies have always faced the challenge that newer technologies can make them redundant. So far, they have managed to beat such concerns,” says Sonam Udasi, fund manager, Tata Asset Management. Analysts believe these companies can return between three and 25 per cent over the next one year.

Telecom: If you take a contrarian call on this sector, you will need to be patient, as the companies here face many issues. Competition is high, requiring incumbents to spend heavily on capex and on spectrum. The entry of Reliance Jio might also lead to rate wars and, hence, reduction in margins. In the long term, however, there are many positives for the industry. The biggest is that consolidation is taking place, which will lead to the existing big players getting a disproportionate share of the market. Analysts believe that companies in this sector can return 8-22 per cent over the next 12 months.

Energy: This is a vast space that includes oil exploration companies, oil marketing firms and utilities. “As the price of oil rises, investors betting on exploration companies can hope for decent returns,” says G Chokkalingam, founder, Equinomics Research & Advisory.

Contrarian investing is not all about betting against the crowd, say experts. Before you invest, check valuations of the company, management quality, growth prospects and debt on the balance sheet. Investors shouldn't go overboard with contrarian bets and skew their portfolio with companies in specific sectors alone. Your equity portfolio should remain diversified across sectors. Therefore, you could cap sector exposure at 20 per cent of the portfolio. Another trick is to put a stop-loss on your stocks to protect you from downside risks. Making mistakes is fine, perpetuating these is not. An investor needs a system that will help her recognise and correct mistakes early.