Investment Styles and Market Cycles

Our purpose in this paper is to offer an analysis of Tocqueville’s contrarian value investment style over a period covering several economic and stock market cycles. To that end, we have selected one large portfolio for which performance figures are available over a period of 24 years. Therefore, the information presented herein is not intended to be in compliance with the Association for Investment Management and Research (AIMR) standards.

This portfolio accounts for a significant portion of the money under our care, and we believe these figures are representative of our contrarian value-oriented style. Nevertheless, we urge you to read the following disclaimers before proceeding to the analysis of these accounts' performance.

The returns listed in this article are based upon the actual annual returns for each of the last twenty-six years for one large account, which was managed by François Sicart, founder and Chairman of Tocqueville Asset Management. The account predates the formation of Tocqueville on January 1, 1990, and was managed by Mr. Sicart initially as an executive of Tucker Anthony, R.L. Day, Inc. beginning in 1977 through the formation of Tocqueville. While representing a significant portion of the total assets under management, the results shown represent a separate composite of Tocqueville, and its publication is not intended to infer Tocqueville’s compliance with AIMR-PPS standards. This account is included in the firm’s current equity composites, along with other similarly managed accounts. Other accounts were managed by Mr. Sicart during the same period, and may have had different investment objectives and achieved different results. All results are the actual performance of the one account only, and nothing contained herein is intended to imply or guarantee that a new account with the same investment objectives and style will achieve similar results in the future.

Highlights

· Over the long term, a contrarian value investment discipline tends to yield returns similar to those of the stock market, but generally with less volatility and, we believe, less risk.

· Specifically, contrarian value investing tends to lag during periods of great stock market buoyancy, and to outperform when the stock market shows low or negative returns.

· Our sample portfolio’s performance has generally reflected these tendencies.

· After being abnormally high for several years, stock market returns turned negative in 2000 and may remain below their historical averages for much of the coming decade. We believe that, in such an environment, our contrarian value style of investment would, again, outperform the general market.

Investment Performance

	Tocqueville Asset Management (one account)	S&P 500 Index	US T-Bill
77	-5.30%	-7.40%	5.20%
78	12.70%	6.40%	6.90%
79	35.50%	18.20%	10.10%
80	25.50%	32.30%	11.80%
81	-0.40%	-5.00%	16.10%
82	30.00%	21.90%	12.70%
83	27.30%	22.40%	9.20%
84	-1.40%	6.10%	11.00%
85	27.30%	31.10%	8.40%
86	2.50%	18.60%	6.70%
87	4.50%	5.10%	6.40%
88	20.90%	16.80%	6.80%
89	14.60%	31.40%	8.90%
90	-1.00%	-3.30%	8.50%
91	12.80%	30.50%	6.40%
92	14.30%	7.60%	3.90%
93	21.90%	10.10%	3.30%
94	2.00%	1.30%	4.20%
95	23.00%	37.60%	6.20%
96	19.40%	23.00%	5.50%
97	14.10%	33.40%	5.60%
98	2.60%	28.60%	5.70%
99	17.30%	21.10%	4.60%
00	5.70%	-9.10%	6.50%
01	1.80%	-11.90%	4.60%
02	-4.10%	-22.10%	1.90%
03	43.10%	28.70%	1.10%
04	10.10%	10.90%	1.50%
05*	11.90%	4.90%	3.10%
Annualized Past 10 years	11.52%	9.07%	3.98%
Shaded = Periods of out Performance * Unaudited performance

Notes

1. The performance presentation above is not in compliance with AIMR-PPS. The performance presentation represents the results of a selected fully-discretionary account managed by the owner of Tocqueville Asset Management L.P. (the “Firm”).

2. The returns were calculated using a time-weighted monthly rate of return formula and are presented net of advisory fees, commissions and transaction costs. The annualized rate of return is equivalent to the annual rate of return which, if earned in each year of the indicated multi-year period, would produce the actual cumulative rate of return over the time period.

3. The benchmarks for the supplemental information are the Standard & Poor’s 500 Index and the 90-Day US Treasury Bill.

The Impact of Cash Reserves and Asset Allocation

Our clients' portfolios are invested mostly in US equities, but they also may include international equities, American and international bonds, non-marketable investments and cash equivalents. More importantly, they are constructed with each client’s particular needs in mind (income requirements; international exposure and currency in which each client lives; tax considerations and long-term financial planning requirements). Thus, the custom-made characteristics of our portfolios make a direct comparison with the S&P 500 index alone somewhat irrelevant.

For example, to the extent that we generally manage most of our clients’ fortunes, we tend, at all times, to hold higher precautionary cash reserves than mutual funds or than the popular stock market indices, such as the Standard & Poor's 500 Index, which include no cash at all.

When markets exhibit a strong uptrend, as in the United States over the last two decades, these cash reserves, held for emergencies, unforeseen needs or precautionary reasons, tend to weigh down the overall portfolio performances. Any advantage that might have been gained from superior stock selection was thus mitigated, in our case as managers of private fortunes, by the handicap of maintaining precautionary cash reserves throughout a period of generally rising markets.

We do not have separate statistics for the portfolio’s individual asset classes prior to 1994. For the period 1994-2000, however, our sample account held only 68.8% of its assets in US equities, on average. Thus, while the account’s overall performance from the end of 1993 through 2000 averaged only 11.7% per annum, the US Equities portion of the account achieved an average annual return of 16.4%.

Besides the effect of cash reserves and asset allocation, however, there have been some distinct periods of out-performance and under-performance that were directly related to our investment style, as shown on the previous page. This is what we would like to discuss here.

Down Markets

Given the concern that our clients have for preserving capital, we are proud to have always gone down less than the market in difficult years. In fact, we were up 5.7% last year (2000) versus a negative 9% return for the S&P 500!

It should be noted that the performance table understates the extent of stock market declines, because bear markets do not conveniently coincide with calendar years. For example:

· The full S&P 500 decline between late 1976 and early 1978 was about 20%;

· The full “market” decline between late 1980 and mid-1982 was about 25%;

· Between late 1989 and late 1990, the “market” declined about 15%.

During these longer periods, our portfolio declined somewhat more than the annual returns shown in the table would indicate, but they still declined less than “the market”.

We should also point out that recent bear markets have been mild by historical standards. Between late 1972 and late 1974, for example, the market lost almost 45%, and even the all-but-forgotten bear market from late 1968 to mid-1970 erased almost 35% of the S&P 500’s value. Unfortunately, for these two periods, we cannot reconstruct performance figures precise enough to be presentable publicly. Suffice it to say that they were fairly good periods for contrarian, value-oriented investing – in a relative sense, of course…

Finally, one may also notice that the 1987 market crash is all but invisible in this table, because it came and went so suddenly. It did do a lot of damage, however, as the S&P 500’s early-1987 highs were not matched until May 1989. Even so, this "invisible" crash speaks strongly in favor of the long-term holding of investments, because it gave many short-term traders the occasion to get whipsawed into large losses, while a buy-and-hold strategy like ours produced a positive return for the full calendar year.

Altogether, then, our performance tends to be better than the market’s when stocks decline broadly and for an extended period of time. In part, this is due to the cash reserve that our portfolio carries. But our performance in bear markets also benefits from the fact that, at market tops – just before declines get under way – contrarian value stocks do not command the euphoria or complacency premiums included in the price of more popular investments. As a result, they have less to lose to return to "incompressible" value levels. This was, again, confirmed in the bear market that followed the most recent speculative bubble, in 1997-1999, when the NASDAQ index, particularly, suffered severe losses, while “value” stocks were affected to a much lesser extent – and sometimes not at all.

Rising Markets

This brings us to our performance in rising markets. Often, because it is so geared to the selection of individual stocks (rather than to market timing), our portfolio behavior bears little relation to that of the general market. For example, this can be observed in a favorable light for 1978-1979, 1992-1993 or 2000, and in a less favorable one for 1995 or 1997-1998 -- although in all these years the portfolio increased in value.

During the periods of euphoria that precede bear markets, whether they are driven by such concepts as indexing, momentum investing or outright speculation, our portfolio almost always lagged the market indices. This was the case, for example, in 1980, 1986, 1989 and again in 1997-1999. The reason is that, during such periods, the best performing stocks usually are stocks that already have done quite well in preceding years: they no longer represent good value according to our criteria, and we won’t buy them.

In 1995-1997, we suffered the underperformance that characterizes our investment style in the late phases of bull markets. This was principally due to the burden of carrying substantial cash reserves in a strongly rising market. Indeed, somewhat atypically, the U.S. Equity portion of our portfolio "almost" kept pace with the leading stock market indices despite the increasingly speculative market environment.

The Cost of Switching Investments

The year 1984 deserves a special mention. In that year, while the S&P 500 index rose a modest 6.4%, our portfolio declined by 1.4%. The figures are small enough that they would not usually matter, except that they cast an interesting light on the way in which we accumulate and sell stocks.

We try to buy stocks on the way down – a sign that they are out of favor with investors. If they are not actually declining in price, at the very least they are "under-performing" – a professional euphemism for saying that they are going up less fast than the market in general.

As value-conscious investors, we also tend to sell stocks before price peaks, because stocks usually continue to rise after they have reached our price objectives, thus becoming increasingly overvalued by our standards.

The following graph shows what typically happens when we sell one stock and buy a new one.

Between time-points A and B, we are selling stock X that is overvalued but continues to go up, while buying stock Y that is cheap but still going down, looking for a bottom. Obviously, until we have reached time-point B, this switching temporarily has a brake effect on performance, though generally with little impact on long-term results. Moreover, since we seldom buy and sell many stocks in a portfolio simultaneously, this phenomenon is usually spread out over time and its impact on short-term performance is barely visible as well.

In 1984, however, things were different. For various reasons – particularly the timely sale of large energy-related positions during late 1980 and 1981 -- we reached the bottom of the 1981-1982 bear market with ample cash reserves. We were therefore in a position to buy the shares of many quality companies at deeply undervalued prices.

By mid-to-late 1983, however, many of these stocks had risen so fast that they had reached and surpassed our price targets. We thus proceeded to sell them, in order to buy shares of companies that had lagged the strong stock market rally. The switch from stocks with upward trends to ones still going down, when applied to more than a few at the same time, produces a short-term but noticeable brake effect on performance – and that’s what happened in 1984.

In late 1997, too, we suffered the same type of brake effect. Rising stocks attract stock market “groupies” and, at some point, valuations become so excessive that we must sell to abide by our value discipline. In late 1997 (and even more so in early 1998), we thought that there were an increasing proportion of now-overpriced winners in the portfolio. An above-average number of switches toward more reasonably valued investments therefore had to be implemented -- with the results described earlier.

Total Period

As can be seen on the graph below, our sample account slightly edged the S&P 500 over the seventeen years from 1976 to 1994, with a total return for the period of +784%. This was achieved while bearing the burden of precautionary cash reserves, and in typical contrarian value fashion, with a tendency by the account to lag somewhat during late bull markets and to catch up in more subdued ones.

Altogether, looking at our experience of the past twenty-four years, we find that a contrarian, value-oriented investment discipline produces a long-term performance -- over the up and down cycles -- comparable to, or better than, that of the leading indices (adjusting for precautionary cash reserves). Moreover, it tends to achieve this performance in a less volatile fashion than most other investment styles.

After 1994, however, we found it difficult to match the returns of an increasingly “bubbly” market, and our sample account lagged during the second half of the 1990s. As the historically high returns of the past decade are unlikely to be repeated in the coming one, we are confident that the superiority of our contrarian value style of investing should soon resurface.

In our view, after a bubble-like period where most stocks were driven more by price momentum considerations than by fundamental analysis, the performance of value investing strategies since the end of 1999 may presage a return to more traditional valuation criteria within the investment industry. This would allow contrarian/investing to reassert its historical performance superiority.

Fads and Discipline

We have always held that the long-term attraction of the stock market as an investment vehicle is that it allows a nation’s savers to invest alongside the life forces in the economy. Entrepreneurs and industrialists are the ones who create wealth and growth in an economy, and the stock market allows us an opportunity to share in their achievements.

However, to take advantage of this opportunity over periods longer than the life of periodic fads and fashions, investors must take an approach similar to that followed by the entrepreneurs themselves. “How valuable is a specific company at a given price, and how much more valuable can it become over an economic horizon of several years, as opposed to a trading horizon of several weeks or months?” -- this is the fundamental question an investor must answer to invest successfully. And dreaming unrealistically about future earnings from unproven products or technologies has no place in that process.

The past several years have witnessed an exceptional succession of investment fads and bubbles, from the self-fulfilling flood of institutional money into index-aping portfolios in the mid-1990s, to the “tech” bubble of 1997-1999. We believe that fundamental analysis of companies and the use of realistic valuation criteria are now set to regain their predominance in investment decisions – as they always have after speculative periods.

Lower Expectations: Better Opportunities For Value Investors

Interestingly, but not surprisingly, this shift in investor preferences will happen on the backdrop of much lower average stock market returns than those to which we became accustomed in the 1990s. Based on that decade’s experience, many investors still believe that 15%-plus returns from the stock market constitute a modest investment goal. Yet, this is about 50% higher than historical returns from the U.S. stock market, for example. Of course, these historical returns, from a century of experience, include both bull and bear markets, but they also include market bubbles and technological revolutions -- as well as periods of very fast economic growth and their aftermaths.

An average investment performance tends to net out periods of positive and negative returns, but it is good to remember that a stock needs to go up 100% in price to make up for a preceding 50% decline. Let us repeat: a stock which doubles after losing half of its value will merely return to the price at which it started. Beyond the excitement of large short-term gains, therefore, superior long-term performance requires the avoidance of large losses.

Periods of lower average returns for the stock markets do not necessarily mean that equity investments are unattractive. It simply means that investment mistakes become more expensive. And paying due attention to companies’ financial strengths and intrinsic values minimizes the risk of the most expensive mistakes.

While the coming decade is unlikely to allow average returns in the range of those experienced in the last one, there will be ample and outstanding opportunities for value investors to achieve superior returns. In this respect, we are gratified by the performance of our portfolio in the recent global bear market. We believe that the contrarian value discipline followed by the managers of Tocqueville Asset Management should be quite well suited to the more subdued market environment we foresee in the next several years.

Summary

In the preceding analysis, we have tried to present the pros and cons of our investment approach as impartially as we could. The reason is that, while we take pride in our performance over many stock market cycles, we do not believe that the selection of a money manager should rely only on a statistical analysis of investment results – especially over relatively short periods. In fact, when clients come to us principally because of a recent period of superior performance, there is a greater risk of misunderstanding about the kind of relationship between client and money manager that produces the best long-term results.

Our goal is to attract clients who, like our existing ones, will understand our investment process and will feel comfortable with it over several decades, for several generations. This, in turn, will allow us to develop investment goals and strategies that are much more closely in tune with the long-term financial-planning needs of each client and their families. Tocqueville seeks clients who are willing to be patient investors in order to protect their capital and reduce portfolio volatility.