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In describing America more than 170 years ago, Alexis de Tocqueville may have unwittingly anticipated the nature of modern financial markets when he wrote that he knew of no other country in which there was "so little independence of mind." Nowadays, once people become fixated on the desirability of a particular investment, they pile on, often mindlessly, boosting its price and creating a self-fulfilling prophecy. The cycle eventually ends, and many investors, particularly those who have arrived at the party late, take a licking.
Fighting the tyranny of the majority is a dangerous game. Robert Kleinschmidt, who runs the aptly named Tocqueville fund, knows just how dangerous because he approaches stock picking from a diametrically opposed perspective. If the crowd loves a stock, he stays away; only when a stock is reviled does he get interested. And even if his analysis that the crowd is wrong is right, Kleinschmidt may have to wait a long time before the majority accepts his position.
This master contrarian has delivered stellar results since taking over the Tocqueville fund in 1992. The '00s have been particularly successful. The fund (symbol TOCQX) beat Standard & Poor's 500-stock index each year between 2000 and 2007. Over the past ten years to June 2, the fund gained an annualized 7%, beating the S&P 500 by an average of three percentage points per year.
To learn more about this independent thinker's approach to stock picking, read this edited version of our conversation with Kleinschmidt.
KIPLINGER'S: You're more than halfway toward tying the record for the most consecutive market-beating years. What's your secret?
KLEINSCHMIDT: Actually, that's not what I'm most proud of. What I'm most proud of is the fund's dramatic underperformance in 1998 and 1999.
Really?
Our underperformance showed we didn't try to do what we didn't know how to do. I didn't chase things that I didn't understand and whose prices violated my disciplines. I couldn't bring myself to participate in the madness -- the run-up in the 50 biggest stocks in 1998 and the Internet craze in 1999 -- even though it was costly in the short term. But in many respects, the performance since then owes a debt to what we did not do in 1998 and 1999.
Is being a contrarian the primary driver of your investment approach?
Unless you're an ideologue, it's not a good idea to label yourself when you invest money and then confine yourself to the label you've created for yourself. What draws me to a stock is what I perceive to be a negative investor consensus. So I guess you could say that's contrarian. Most of the ideas in this portfolio are stocks for which the prevailing investor consensus was negative when I bought the stock.
Is the consensus always wrong?
No. Very often it is right. My colleague François Sicart likes to say, "Just because everyone says it's raining outside is no reason not to take an umbrella." It's just that the consensus is a very hard place from which to make money because, in most cases, the consensus view is priced into a stock. So I look for stocks for which the consensus is negative and try to make the case that over my time horizon, which is three to five years, the consensus will change.
Didn't some contrarians buy Google after it went public on the grounds that the market didn't appreciate its growth potential?
It's not a stock I owned at $100, but when the stock fell from about $750 last fall to the low $400s in March, I was buying. I now have a 1% position in Google and a profit of $100-plus per share.
Do you pay attention to the economy when buying stocks?
No. It's cocktail chatter. I run the fund almost entirely from the bottom up, stock by stock. But I own some things that are based on top-down judgments. I recently bought an exchange-traded fund called Horizons BetaPro NYMEX Crude Oil Bear (HOD-TSE).
You're betting on oil prices falling?
All the oil-company executives we speak to say they can make money at $40 to $50 a barrel. At $139 a barrel, the rate of return is very high, so I'm convinced that there will be more supply. I'm also convinced that high prices will result in substitution of other energy sources for oil as well as dampen economic activity. As a result, I'm confident (although I've been wrong so far) that when people wake up and see that the emperor really isn't wearing any clothes, the price of oil will fall precipitously. Of course, as my son says, markets can stay irrational longer than you can stay solvent.
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