Contrarian asset allocation is a form of tactical asset allocation where you modify the proportion of assets in your portfolio to chase bad returns.

Chase bad returns? Why would you want to do that? The answer is quite simple, if you try to chase good returns by buying last year's best performing asset class you will end up buying high and selling low every time. The strategy of going in one year late because an asset class did really well over the last 12 months is as sure a method as any of underperforming the market.

What a contrarian does is buy last year's lowest performing asset class, a strategy that has in fact outperformed the market by a handy margin for quite some time. If you want to put 100% of your money into last year's dog then that is your choice, another one might be to have a rolling strategy where you vary your asset allocation dynamically from year to year, selling out of last year's top performing asset class completely but maintaining holdings in the lesser ones.

Note that since 1981 a "purist" contrarian strategy concentrated in last year's worst asset class has outperformed mixed classes. I tested what happens if you put some money into last year's worst as well as the second worst and the results were inferior to holding the absolute worst asset class. On the other hand this second strategy also beat the market itself over time but with significantly lower volatility than the market. If having a diversified portfolio is important to you then a mixed asset allocation might be helpful.

I have prepared a spreadsheet showing the returns since 1981 of each of the asset classes, and a variety of strategies are tested. The highest performing asset allocation strategy I know of is a contrarian one where you invest in any asset class if interest rates are in double digits but only growth assets (shares, property) when interest rates are lower. In this spreadsheet I call this the "Growth dogs if IR>10%" strategy. Returns since 1981 have been 20.67% per annum, comfortably beating all strategic (static) asset allocation strategies and out-pacing the returns of all but an elite few managed funds.

The spreadsheet demonstrates this technique with index tracker funds available from Vanguard, however in all probability it will work for managed funds, individual stock pickers, individual property trusts etc as well.

If you want to take this concept further you can call "value funds" an asset class, "growth funds" as another, "US Equities Funds" and various specialist sector funds such as tech, health care and resources. Get to know what constitutes "cheap" with each of these and buy things at historic lows. An example would be Peter Lynch's observation that small cap growth funds tend to trade in a range between the average market price earnings ratio and approximately double. If you buy small cap growth funds following a period of underperformance when they trade at average PERs you are setting yourself up for a classic contrarian play.

Contrarianism can be used as an extension of ordinary portfolio rebalancing. There is no need to have dividends reinvested in their parent funds, you can collect them in a holding account instead and allocate them entirely to the losing sector. Unless you want to lose a lot of money to capital gains tax and trading expenses, I suggest you don't engage in excessive trading by always rolling 100% of your money into the contrarian asset class. A better strategy would be to start with a balanced portfolio and reinvest dividends in the contrarian sector, and to do the same with your ongoing investment contributions. Keep an eye on overall asset allocation and it might be a good idea to do some selling if allocations get too far out of line of where they should be. Your tolerance may vary, but I prefer not to let any sector get more than 20% from benchmark weighting.

Remember that rebalancing a portfolio back to strategic weightings every year is a mild form of contrarianism, you sell the winners and buy the losers every time you restore a portfolio back to its default asset allocation. A contrarian asset allocator is just rebalancing a portfolio, but instead of using a strategic asset allocation instead uses a tactical asset allocation where the loser sector is given a bigger weighting.