Revealed: The secrets of a contrarian investor

Secrets of a contrarian investor

A contrarian investor buys when the herd sells and sells when the herd wants to buy. Ideally this involves selling when prices are high and buying when prices are low. There is a remarkably simple way to incorporate this into your portfolio.

The Market Vectors Australia Equal Weight ETF (ASX code: MVW) is contrarian.

Each quarter MVW rebalances its holdings so that all stocks are equally weighted. This process involves contrarian trades as it involves MVW:

1. selling stocks that have risen since the last rebalance; and
2. buying stocks that have fallen since the last rebalance.

In a 2012 paper titled “Why Does an Equal-Weighted Portfolio Outperform Value and Price Weighted Portfolios,” researchers from Goethe University Frankfurt, CEPR and EDHEC Business School, pinpointed that this rebalancing process, “is implicitly a contrarian strategy that exploits the reversal in stock prices.” (Plyakha et al, 2012). In other words, MVW’s rebalancing process is a source of outperformance when compared to traditional market capitalisation funds.

Here is an example from MVW’s portfolio.

In February 2014 Qantas cut thousands of jobs and was receiving negative press. In June the company was warning the market about weak demand. Analysts were concerned about the company’s growth strategy and its competitiveness domestically where it once held a monopoly. In the December quarter, Qantas was MVW’s best performing stock. Below is a graph of Qantas’s share price and the trades MVW executed at each rebalance. It illustrates the trade discipline of a contrarian investor.

Qantas share price

Source: Bloomberg, Market Vectors

As you can see from the below, MVW bought Caltex when it was performing poorly relative to the rest of the market. MVW has benefited from its recent price rise in the past six months.

Caltex share price

Source: Bloomberg, Market Vectors

The researchers of the 2012 paper demonstrated how the contrarian rebalancing process undertaken by an equal weight portfolio adds value to the portfolio. If you are interested the 2012 paper is here. The researchers analysed the United States’ S&P 500 Index, a four-factor model and an equivalent equal weighted portfolio. The equal weighted portfolio was the best performing.

MVW tracks the Market Vectors Australia Equal Weight Index. An analysis of the returns of the S&P/ASX 200 Accumulation Index and this equal weight index shows that the equal weight index outperforms over the long term.

Source: Factset, Market Vectors, 31 January. You cannot invest directly in the indices. Figures assume immediate reinvestment of all dividends and exclude management costs and brokerage costs associated with investing in a fund which tracks any of the above indices. The above performance information is not a reliable indicator of current or future performance of the above indices, which may be lower or higher.

By rebalancing quarterly MVW behaves as a contrarian investor buying when prices have fallen and selling when prices have risen. This process is one of the reasons the Equal Weight Index has outperformed the traditional market capitalisation index over the long term.

For more information on MVW, click here, email us or call 02 8038 3300.