This is part II of the article Contra Funds: An Introduction to Contra Funds
. Please read the first part before proceeding with this one.
However, Contra fund investment style does not necessarily guarantee any sure shot returns. The best way to defy a claim is to attack the underlying assumptions of that claim. For a contra fund, the most important underlying assumption is that the fund manager and research analysts claim to identify such undervalued low price stocks. Is it really possible for anyone to identify such stocks? Well, not at all. As I’ve proved in my previous articles: Stock Picking: Good Company v/s Bad Company, Equity research, Analysis & the recommendations and The Stock Trading Markets: Traders and Market Makers, there is no way one can identify any specific stocks with the publicly available information. The only way one can do so is if he is LUCKY or has insider information about a company. However, trading on insider information is illegal.
A simple way to prove that contrarian approach of fund management may not work is with the huge size of the market. As I’ve proved in the previous articles, markets are huge and people are just waiting for profit booking opportunities. Fund managers have to deal with big amount of money, for e.g. recently, Reliance mutual fund was able to gather almost 5900 crore Rs. from the market. When the fund manager has to manage a big amount of money like this, he has to invest by buying big no. of stocks in huge quantity. The moment a fund manager places an order for buying a particular stock, the market senses it and immediately the prices start to rise. It is possible that an initial portion of the order gets executed at a lower price, but majority of the order gets executed at a higher price. Here’s a simple example:
A MF manager places order to buy 20 Lakh shares of XYZ Company currently trading at a price of 500 Rs. It is possible that first 1 lakh shares are bought at 500 Rs., but soon the market senses that there is a big demand (19 lakh shares) for XYZ shares and the price starts to go up. So the remaining order of 19 lakh shares is fulfilled at a much higher price and the total average price that is paid for the entire order is huge. A practical way to prove this is that we often here that ABC stock has gone up by 5-10% today and was the main winner for today trading. The reason for the stock price of a particular stock to shoot up so much is either it has some major profitable news (great income reporting, bagging order worth billions, a new discovery or something similar) or an MF manager buying this stock in big nos. causing the prices to go up. Hence, ultimately the market, and not the MF manager decides the price of the stock that he purchases and he ends up paying the market price. The profitable opportunity is lost there itself. If any such opportunity exists, it exists only in the long run, that too based on the assumption that the business will sustain, it will not have competition, it will be profitable and similar loads of conditions.
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