Investing in the stock market requires a strategic approach and a thorough understanding of market trends and dynamics. One popular adage that resonates with investors worldwide is “Buy low, sell high.” This notion encapsulates the essence of investing in underperforming sectors.
Investing in underperforming sectors is often referred to as the contrarian approach. It involves taking a position opposite to prevailing market sentiment, which is usually bearish during times of sector underperformance. Contrarian investors believe that markets are not always efficient and tend to overreact to short-term events, leading to undervaluation of certain sectors or stocks.
Advantages of Investing in Underperforming Sectors
Lower Entry Price: Investing in underperforming sectors allows investors to purchase stocks at lower prices. When the sector eventually rebounds, these investments can yield significant returns.
Potential for High Returns: As underperforming sectors recover, stock prices have the potential to surge, providing investors with attractive gains.
Reduced Downside Risk: While any investment carries inherent risks, buying into underperforming sectors at low prices can mitigate potential losses since stock prices are already discounted.
Diversification Benefits: Adding underperforming sectors to an investment portfolio can enhance diversification, reducing overall portfolio risk.
Long-Term Growth Opportunities: Industries experiencing temporary setbacks may have long-term growth prospects that investors can capitalize on.
Examples of successful contrarian investments in the Indian equity market:
IT Sector (2001-07):
During the dot-com bubble burst in the early 2000s, the Indian IT sector faced significant underperformance. However, contrarian investors who recognized the long-term potential of the industry were rewarded handsomely as the sector rebounded and experienced remarkable growth in subsequent years.
During 2000-01, IT sector corrected by 85% – providing a reasonable valuation to invest.
A SIP in ICICI Prudential Technology Fund (from 2001-2007) delivered an annual return of 44%.
Banking Sector (2008-10):
In the wake of the global financial crises, India’s banking sector faced considerable challenges. However, those who adopted a contrarian approach and invested in fundamentally strong banks witnessed substantial gains as the sector rebounded amidst economic recovery.
During 2007-08, banking sector corrected by 60% – providing a reasonable valuation to invest.
A SIP in Nippon India Banking Fund (from 2008-2010) delivered an annual return of 50%.
Auto Sector (2019-2023):
The Indian auto sector faced a slowdown during 2019-20 due to various factors, including economic slowdown, liquidity crunch, and changes in regulations. Many leading automobile companies’ stock prices experienced a significant decline. However, investors who recognized the sector’s importance in the Indian economy and its potential for recovery made strategic investments. As the economy gradually improved and consumer demand picked up, the auto sector started to rebound, leading to substantial gains for those who invested during the downturn.
During 2018-20, auto sector corrected by 60% – providing a reasonable valuation to invest.
A SIP in UTI Transportation Fund (from 2019-2023) delivered an annual return of 23.25%.
Pharmaceuticals Sector (2017-2021):
In 2017 & early 2018, the Indian pharmaceutical sector was under pressure due to increased scrutiny by regulatory agencies, pricing pressures in international markets, and increased competition. As a result, several pharma stocks witnessed a bearish trend, creating an opportunity for contrarian investors. Investors who had confidence in the long-term growth prospects of the Indian pharmaceutical industry and chose fundamentally strong companies with robust pipelines benefited from the sector’s eventual recovery.
During 2016-20, pharma sector corrected by 45% – providing a reasonable valuation to invest.
A SIP in DSP Healthcare Fund (from 2019-2021) delivered an annual return of 46%.
Smallcap funds:
Contrarian investing can be applied to funds based on market capitalization as well (Large, Mid and Small). Smallcaps performed very poorly from 2018-2020, correcting by 50-80% in some cases. In mid 2020, we recommended to invest in UTI Smallcap Fund to take the benefit of cheap valuation of smallcaps. Today, the portfolios highlight the return of the contrarian call we made.
While the contrarian approach can be rewarding, it is essential to acknowledge its inherent risks:
Market Timing: Identifying the right time to invest in an underperforming sector can be challenging, as market sentiment can be unpredictable.
Fundamental Analysis: Investors must conduct thorough fundamental analysis to ensure they invest in fundamentally strong companies within the underperforming sector.
Patience and Long-Term View: Contrarian investments may take time to materialize (usually 2-4 years), requiring patience and a long-term investment horizon.
Investing in underperforming sectors can be a prudent strategy for those willing to adopt a contrarian approach. By purchasing undervalued stocks during periods of underperformance (preferably through SIP), investors position themselves to benefit from potential future growth when the sector eventually rebounds. However, successful implementation of this strategy necessitates careful research, sound fundamental analysis, and a long-term perspective.
