Ryan Leggio: Hi, this is Ryan Leggio. I'm a fund analyst at Morningstar. And with me today is John Hussman. We asked readers to submit questions for Dr. Hussman and here are three of the best we received.
This comes from Richard Lorenz and his question is this, "To many people, you are the funds. If something happens to you, the funds are in peril. Your interpretation of the data and your timing of purchase sales seem to be crucial. What would you tell a long- term investor about this concern?"
John Hussman: I think very honestly, at present investors are in a similar situation as with any good manager that part of what I do is personal to me. On the other hand, we do have a lot of modeling that we have here that we've worked on over years that we have gradually been building out into systems.
I very honestly can't say that if that happened tomorrow we would be in a position where everything that I do would be matched by a sub-advisor. But we do have a lot of the stock selection methodologies, a lot of the objective things that I look at are also things that are objective and that Bill Hester's been working on for a while also.
A few months ago we started our international fund with Bill and I co-managing. And that's another thing that we're planning to do over time is to build out staff so it's not just me managing the funds. But very honestly that will take a few years. That's something that we're working on expanding.
Ryan Leggio: In your fund reports, your break down the returns of your funds by stock performance only. Have you considered opening a fund for investors who want access to your stock selection without the effects of hedging?
John Hussman: I've thought about that a lot. Here's the dilemma that we have. If you look at the performance of the strategic growth fund since its inception, it's clear that the hedging has added value.
It's also reduced volatility. The overall performance of the strategic growth fund exceeds the performance of the individual stock selection and with significantly less volatility and risk.
So for an investor who has a full cycle mentality and who has a full cycle perspective, taking off the hedging doesn't make a lot of sense, really what taking off the hedging would do would be to improve the tracking risk of the portfolio? In other words, to allow the portfolio to track market fluctuations both up and down better.
My own concern is that to allow that additional tracking risk comes at the expense of a lot of potential loss. And it's not clear to me that investors would always be on the right side of that trade.
My expectation would be that after, for instance, an advance that we've seen over the last year, the strategic growth fund has not tracked well at all. Our stock selections certainly have, the problem is that a new investor would be likely to get into which one right now? They would be likely to get into the un-hedged one. Whereas I would be frantic to have them make the other choice.
So as paternalistic as it may sound, I would rather have--if I'm going to be the manager of someone's money, I would rather not expose those investments to very large risks that I expect are coming and that I at least have demonstrated a track record of having some skill in anticipating to the point where the hedging has actually out-performed the raw-stock selection only.
Ryan Leggio: What would be your response to an investor that believes that your investment strategy is veiled market timing?
John Hussman: Veiled market-timing. To the extent that someone is an investor, I think it's appropriate to accept greater risk when stocks are priced to deliver strong returns per unit of risk and to mute the risk-taking when stocks are not priced to deliver strong returns per unit of risk.
To the extent that varying one's exposure to market risk is market- timing, I guess I can't deny that characterization. Because really, it seems to me that if you look back at 2000 and you were to look at the valuations at the time and by our methodologies, stocks were priced to deliver a total negative return over the next decade which they in fact did with a great deal of risk.
To say, well, no, I'm going to disregard the characteristics of the market, I'm going to disregard the valuation level of the market and just assume that regardless of the level of valuation, stocks are always going to be priced to return 10%. I'm just going to say, well, what matters is time in the market, not market timing. So I'm going to just sit in stocks for the next decade regardless of how they're priced.
That investor has lost money and has gone through an enormously painful convoluted route to lose money.
So, to some extent, what we're trying to do is to expand our risk- taking when stocks are priced to deliver a strong return to risk profile and to contract our risk-taking otherwise.
What happened last year in 2009 because this has come up before wasn't so much what was likely on the return side was what was likely on the risk side. I'm still not comfortable that we're past that because I think that potential risks are quite high.
Now that the market is richly valued, again, I think the expected returns are quite low which is what places us in well-hedged positions.
So to the extent that we don't always take a passive fixed exposure to the market, whatever variation we have I think can be characterized and possibly fairly as market-timing, but I think if you look at the historical relationship between valuations and subsequent returns, it's also clear that there's a role for that.