Bank of America has discovered a simple trade that’s tripled the market's return: Buy stocks the 'smart money' hates. Here’s how you can get involved.

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It can pay to be a stock-market contrarian. Bank of America has taken that to an extreme and uncovered a surprisingly strong market-beating strategy.

Going against the grain can be a profitable technique in situations where a market dynamic has gotten overstretched, since that makes it more prone to a vicious snap-back. It can also be a good way to find bargains in unloved stocks whose upside is underappreciated., which recognizes the massive value embedded in such a technique.

The firm has studied years of market behavior and found that the contrarian approach of buying the stocks most underweighted by large-cap active funds and selling their most overweight holdings has"consistently generated alpha." But wait, there's more. BAML has pushed this idea to an even further extreme — one that involves buying the stocks most reviled by both hedge fundsIn order to arrive at this conclusion, BAML divided both hedge- and mutual-fund holdings into quintiles, ranked by relative weight. The hedge fund groups were viewed on a scale ranging from most-long to most-short, while mutual funds were segmented by how crowded or neglected their assorted holdings are.

BAML's surprising finding can be found in the chart below. As you can see from the dark green cell in the bottom right, stocks that were both the most shorted by hedge funds and most neglected by long-only mutual funds returned 16.3% over the past year. That's more than triple the 4.

As shown in the chart below, the two sectors least loved by both hedge and mutual funds are real estate and consumer staples. Further, utility stocks are particularly hated by mutual funds. As such, those areas are likely your best bet for replicating the success of BAML's study.

 

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