Uncommon Value: The Characteristics and Investment Performance of Contrarian Funds

Abstract

Theories of herding behavior predict that only investors with sufficiently precise private information or those most overconfident will deviate from the crowd. Using portfolio holdings, this paper identifies contrarian funds as those pursuing distinctive investment strategies, i.e., as those most frequently trading against the “herd” (against the majority of funds). We find that contrarian funds tend to experience greater inflows and past performance, indicating that their managers either have lower career concerns or are overconfident when trading against the crowd. Our analysis of both fund holdings and trades reveals that contrarian funds possess superior stock selection information (rather than merely being overconfident), and also frequently benefit from their provision of liquidity to herding funds by trading against them. As a consequence, contrarian funds exhibit significantly higher Carhart (1997) four-factor alphas, net of expenses, even after controlling for various performance-relevant fund characteristics. We further compute a stock-level contrarian score that reflects the aggregate information possessed by contrarian funds. Top-decile contrarian stocks outperform bottom-decile stocks by a characteristic-adjusted return of 0.49% per quarter during the four quarters after portfolio formation. Further investigation shows that the stock selection information captured by the contrarian score is not subsumed by the return-predictive information contained in an extensive list of quantitative stock characteristics derived from past research. Our findings suggest that contrarian managers possess unique fundamental stock information.