SBI Contra Fund: A good investment choice in current market situation

Contra is an investing strategy which is opposite to the market trend. Contra fund managers invest in stocks that are currently underperforming due to short term issues but which have good growth potential in the medium to long term.

Warren Buffet’s famous quote, “be fearful when others are greedy and greedy when others are fearful” captures the essence of contra investing. We think that in the current equity market conditions when Nifty is at all-time high, contra can be a good investment strategy for long investment horizons.

In this blog post, we will review SBI Contra Fund. The fund is a proven wealth creator. Rs 1 lakh invested in the fund at the time of its inception (July 1999) would have grown to Rs 30 lakhs in around 20 years (as on 19^th November 2020).

Difference between Contra and Value Fund

Before we move further, it is important to clarify the difference Contra and Value Funds because investors get confused between the two. Value fund managers invest in stocks which are trading at discount to what the fund manager thinks are the intrinsic values of such stocks. In his letter to Berkshire Hathaway investors in 1992, Warren Buffet wrote that “growth and value investing are joined at hip” because “growth is always a component in calculating value”. Contra fund managers invest in stocks which are currently out of favour because the market does not expect them to do well, but the fund manager does. Essentially, contra fund managers invest in high conviction stocks which they think the market is mispricing due to some reason.

Why invest in contra funds?

In India, growth investing is the most popular strategy, but having a portion of your portfolio invested in contra funds can enhance portfolio good returns across different market conditions in the long run. This is because all the segments of the market are cyclical in nature and businesses tend to be in and out of favour. If you can invest in quality stocks (through a contra fund) which are currently out of favour for whatever reason, you can get good returns, when these stocks are back in favour and are rewarded by the market.

Why is this a good time to invest in contra funds?

According to Dinesh Balachandran, fund manager of SBI Contra Fund, “Covd-19 has led to severe dislocation in the market where many stocks have gotten significantly de-rated simply due to near term uncertainty. This is apparent even more in the small and midcap space due to lack of adequate liquidity. This has consequently opened up opportunities for the fund to invest in such names”. Mr Balachandran believes that “only a small part of company’s valuation is based on near term earnings. However the market sometimes over-reacts to this near-term uncertainty”.

SBI Contra Fund – Investment Strategy

• Sector level


• Identifying sectors which are currently out of favour, although have long term potential


• Stock level:
• Identifying companies wherein the stock is trading at lower than its intrinsic value. The focus is 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


• Companies which have strong fundamentals but are available at discounted values owing to short term performance issues

How is SBI Contra Fund playing its contrarian strategy?

• Market Cap Segments

The rally over the past few months has taken large cap valuations to levels significantly higher than pre-COVID levels (see chart below). In fact large cap PE multiples are higher than what we saw in December 2007, just before the great recession and crash of 2008.



Source: Bombay Stock Exchange


The chart below shows the market allocation trend of SBI Contra Fund over the past 12 months (ending September 2020). The fund is overweight on small caps versus its benchmark BSE 500 TRI.



Source: SBI MF


“Small cap stocks, on the other hand, currently offer better scope for returns as there are many stocks in this space that offer a good combination of reasonable valuations and growth visibility. There are attractive investment opportunities even in the midcap segment due to the COVID driven de-rating. Many of their large cap peers, in contrast, are trading at expensive valuations for a similar or lower growth profile” according to Dinesh Balachandran, fund manager of SBI Contra Fund.


• Industry Sectors
  
  The fund manager is overweight on sectors where he expects strong earnings recovery once we are past the near term economic crisis. There is good news of a COVID-19 vaccine on the horizon in 2021 and we are seeing green shoots of recovery from the recent economic indicators and industry data. We expect the sectors where the fund manager is overweight to outperform, once growth returns to the Indian economy. One point for investors and financial advisors to note here is that the fund manager will reduce the underweight in financial sector there is more clarity around NPA issues faced by the sector.We agree with the fund manager’s near term cautious stance with respect to banking and financial services sector.
  
  

  Source: SBI MF

  
  Please note that nearly 10% of portfolio is in new entrants in the Jul to Sep quarter. According the Fund Manager “significant dislocation in the market this year has opened the doors for investing in stocks with very good risk-reward ratio. The fund has tried to capitalize on this trend to the extent possible. In general, we believe that only a small part of company’s valuation is based on near term earnings. However the market sometimes over-reacts to this near-term uncertainty”.

About SBI Contra Fund

The fund was launched in July 1999 and has Rs 1,336.74 Crores of assets under management. The expense ratio of the scheme is 2.33%. The fund has performed very strongly in the last one year (see the chart below).

Source: Advisorkhoj Research

Conclusion

In this blog post, we have discussed how contra investment strategy can work to investors’ advantage in the current market conditions. However, you need to have moderately high appetite for volatility and long investment tenures. SBI Contra Fund has a long term wealth creation track record. The fund manager also has a good track with respect to this scheme and other schemes (e.g. SBI Long Term Equity Fund, formerly known as SBI Magnum Taxgain and SBI Dynamic Asset Allocation Fund) he has managed. SBI Mutual Funds as an AMC has a fantastic track record of having the best performing schemes across several categories. The fund manager’s strategy in SBI Contra Fund is sound and seems to be paying off given the strong outperformance of the fund in the last 6 months or so. Investors should consult with their financial advisors if SBI Contra Fund is suitable for their investment needs.