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INTRODUCTORY BOOKLET
Table of Contents
How To Use The HFD 2What’s Included In Your HFD Subscription 2Why You Should Ignore Short-Term Gains 3Other Ways of Accessing HFD Data 3How We Calculate Performance 4Frequently Asked Questions 4Risk & Risk-Adjusted Performance 6The HFD’s Timing Scoreboard 8Newsletters’s Most Popular Stocks 9The HFD’s Sentiment Indices 10Methodology Used To Follow 11 Ambiguous Advice
Mark HulbertDear Investor,
Congratulations! If used properly, the Hulbert Financial Digest monthly
newsletter will help you steer clear of bad investment advice and direct you to
the advice that will better your investment performance.Mine is no normal investment newsletter. I will not tell you where to
invest. But I will tell you whose advice is working.I am not affiliated with any of the newsletters I rate and therefore can be
completely objective in my analyses of investment newsletter performance.Read through this booklet explaining how best to use the Hulbert Financial
Digest monthly newsletter and keep it handy as a reference.Thank you for your subscription. If you have any questions, please
write or call. If you’re online, you can e-mail your questions or comments to
Sincerely,
Mark Hulbert, EditorP.S. Each month’s HFD reports performance through the last business day
of the previous month. Because we won’t publish until all our calculations
are complete, we can’t predict the exact day on which you'll receive your
issues. But typically the monthly HFD issues are published at the end of the
first week of the month.P.P.S. If you subscribe electronically, you should receive your issues almost
immediately after they’re published. Print subscribers will receive theirs
once they are printed and mailed second class from Washington, D.C.HFD • c/o Dow Jones Online Customer Service • P.O. Box 300 •Princeton, NJ 08543-0300 • (888) HULBERT
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How to Use The Hulbert Financial DigestWWWWWe presume that you subscribed to the Hulbert Finan-
cial Digest (HFD) at least in part in order to deter-mine which investment newsletter(s) are worth following.The most important thing to keep in mind when picking anewsletter: There is no one “perfect” newsletter for allThere is no one “perfect” newsletter for allThere is no one “perfect” newsletter for allThere is no one “perfect” newsletter for allThere is no one “perfect” newsletter for alltypes of investorstypes of investorstypes of investorstypes of investorstypes of investors. Therefore, the best the HFD can do isarticulate several principles that you should follow as youstudy the HFD’s performance ratings.
Rule #1: Don’t Put TRule #1: Don’t Put TRule #1: Don’t Put TRule #1: Don’t Put TRule #1: Don’t Put Too Much Woo Much Woo Much Woo Much Woo Much Weight On Shorteight On Shorteight On Shorteight On Shorteight On ShortTTTTTerererererm Perm Perm Perm Perm Perforforforforformancemancemancemancemance
Performance over the recent past is an exceedingly un-reliable guide to which adviser will perform well in the fu-ture (see article on page 3 of this booklet). When judging anadviser, always take into account as much of his perfor-mance history as is available. It is because of this rule thatthe performance scoreboards that appear on pages 7 and 8of each HFD always focus on performance over periods ofat least five years in length.
Rule #2: Pay Attention TRule #2: Pay Attention TRule #2: Pay Attention TRule #2: Pay Attention TRule #2: Pay Attention To Risko Risko Risko Risko RiskOnce you are focusing on longer-term performance, you
should interpret a newsletter editors’s record in the contextof how much risk he/she incurred (see pages 6 and 7). It isbecause of this rule that the HFD’s monthly scoreboardsrank newsletters two different ways—both on a raw-returnbasis and on a risk-adjusted basis. Other things beingOther things beingOther things beingOther things beingOther things beingequal, we suggest you pay more attention to the risk-equal, we suggest you pay more attention to the risk-equal, we suggest you pay more attention to the risk-equal, we suggest you pay more attention to the risk-equal, we suggest you pay more attention to the risk-adjusted rankings than to the non-risk-adjustedadjusted rankings than to the non-risk-adjustedadjusted rankings than to the non-risk-adjustedadjusted rankings than to the non-risk-adjustedadjusted rankings than to the non-risk-adjustedrankings.rankings.rankings.rankings.rankings.
Rule #3: Subscribe First on a Trial BasisRule #3: Subscribe First on a Trial BasisRule #3: Subscribe First on a Trial BasisRule #3: Subscribe First on a Trial BasisRule #3: Subscribe First on a Trial BasisBefore you actually begin investing according to a
newsletter’s advice, you should follow the newsletter for awhile on a trial basis. That way, you can determine whetheror not you would be comfortable with the newsletter’s ap-proach. For example, does the newsletter have a telephonehotline? Many have daily updates. Are you willing or able tocall that hotline this often? Furthermore, how often doesthe newsletter recommend transactions?
Rule #4: Have A Contingency PlanRule #4: Have A Contingency PlanRule #4: Have A Contingency PlanRule #4: Have A Contingency PlanRule #4: Have A Contingency PlanThis last rule is necessary because, unfortunately, there
are no guarantees: Though you increase your odds of suc-cess by choosing a newsletter wisely, there’s no assurancethat it will perform as expected. Therefore, we suggest youformulate in advancein advancein advancein advancein advance what would lead you to stop follow-ing your chosen newsletter and subscribe to another one.
Do notnotnotnotnot wait until after you have started following yourchosen newsletter. This is because, at that point, your emo-tions kick in and you lose your objectivity. Every adviser,even the best ones, suffer through periods in which they arenot in synch with the market. If you don’t have a contin-gency plan, you’re likely to bail out at just the wrong time.
Be sure to adhere to whatever plan you formulate. Forexample, let’s assume that you have decided to follow a news-letter because it has beaten the market on a risk-adjustedbasis over the last 15 years. A good contingency plan mightbe to continue following it so long as its trailing 15-yearrisk-adjusted return is ahead of the market.
AAAAAs a subscriber to The Hulbert Financial Digest, you will re-ceive 12 monthly issues. In ten months of the year (all those
other than January and July), each issue will be eight pages inlength. The January and July issues will be 24 pages long, consist-ing of 8 pages that conform to our regular monthly publishingtemplate and 16 pages devoted to the latest update of our Long-Term Performance Ratings.
Regular 8-Page Monthly IssuesRegular 8-Page Monthly IssuesRegular 8-Page Monthly IssuesRegular 8-Page Monthly IssuesRegular 8-Page Monthly IssuesPerformance scoreboardsPerformance scoreboardsPerformance scoreboardsPerformance scoreboardsPerformance scoreboards: Each issue of the HFD providesrankings of the top five performing newsletters, on both a totalreturn and a risk-adjusted basis, over the trailing periods over aslong as the last 20 years. The scoreboard on page 8 focuses on allservices in the HFD’s database, while the scoreboard on page 7 ofeach issue focuses on just those that recommend mutual funds.Four full-page newsletter profilesFour full-page newsletter profilesFour full-page newsletter profilesFour full-page newsletter profilesFour full-page newsletter profiles: On pages 3 through 6 of eachmonthly issue, the HFD profiles four of the newsletters that ap-pear, or have recently appeared, in the page-7 or page-8scoreboards. Thus, over the course of a 12-month subscription tothe HFD, you will receive profiles of as many as 48 top-performingnewsletters. The full-page profiles include graphs comparing thenewsletters’ performances to the Dow Jones Wilshire 5000, de-tailed analysis of the newsletters’ riskiness and average holdingperiod, and commentary by HFD editor Mark Hulbert.Analysis by Mark HulbertAnalysis by Mark HulbertAnalysis by Mark HulbertAnalysis by Mark HulbertAnalysis by Mark Hulbert: The first two pages of each HFD aredevoted to an in-depth analysis by Mark Hulbert of an investmenttopic that emerges from his more than two decades of tracking ofinvestment newsletter performance.Newsletters’ most popular stocks and mutual fundsNewsletters’ most popular stocks and mutual fundsNewsletters’ most popular stocks and mutual fundsNewsletters’ most popular stocks and mutual fundsNewsletters’ most popular stocks and mutual funds: Thislisting appears in a box on page 7 of each monthly HFD. Thelisting shows which stocks and funds are most recommended by
What’s Included In Your HFD Subscriptionthe investment newsletters the HFD tracks, along with how manynewsletters are recommending each stock and fund. The box alsoshows which stocks and funds are most liked by newsletters thathave outperformed the market over the last decade, as well asthose stocks that are least liked. For a detailed discussion of theselistings, see page 9 in this Introductory Booklet.The HFD’s Advisory Sentiment IndicesThe HFD’s Advisory Sentiment IndicesThe HFD’s Advisory Sentiment IndicesThe HFD’s Advisory Sentiment IndicesThe HFD’s Advisory Sentiment Indices: These indices arereported each month in a box at the bottom of page 7. In this boxyou’ll see the average equity market exposure among all newslet-ters the HFD follows that offer stocks/cash allocation advice, aswell as among those newsletters that have beaten the marketover the last decade on a risk-adjusted basis. Similar indices ap-pear for the gold and bond markets as well. For a detailed discus-sion of these indices, see page 10 in this Introductory Booklet.
Long-TLong-TLong-TLong-TLong-Term Performance Ratings Issueserm Performance Ratings Issueserm Performance Ratings Issueserm Performance Ratings Issueserm Performance Ratings IssuesThese 16-page supplements are included with the Janu-
ary and July issues, and cover performance through the previousDecember 31 and June 30, respectively. Every newsletter the HFDfollows is included in these issues, along with each of their indi-vidual portfolios that are monitored. For each newsletter and port-folio, total return and risk-adjusted performances are listed overthe previous year, and the last 5, 10, 15, and 20 years as well asover the entire period the HFD has monitored the newsletter. TheLong Term Performance Ratings issues also report each portfolio’srisk, average holding period, and the HFD’s clarity rating.
The Long Term Performance Ratings issues also includetiming-only ratings for those newsletters that offer market tim-ing advice. For a full discussion of how these timing-only ratingsare calculated, and what they mean, see page 8 of this Introduc-tory Booklet.
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TTTTTable 1. Perable 1. Perable 1. Perable 1. Perable 1. Perforforforforformances of strategies that eachmances of strategies that eachmances of strategies that eachmances of strategies that eachmances of strategies that eachJanuary 1 invest in the top performing portfoliosJanuary 1 invest in the top performing portfoliosJanuary 1 invest in the top performing portfoliosJanuary 1 invest in the top performing portfoliosJanuary 1 invest in the top performing portfolios
over the previous 1-, 5- or 10-year periods.over the previous 1-, 5- or 10-year periods.over the previous 1-, 5- or 10-year periods.over the previous 1-, 5- or 10-year periods.over the previous 1-, 5- or 10-year periods.(January 1, 1991, to August 31, 2005)(January 1, 1991, to August 31, 2005)(January 1, 1991, to August 31, 2005)(January 1, 1991, to August 31, 2005)(January 1, 1991, to August 31, 2005)
SSSSShort-term returns a very poor guide to future per-formance. It is far better to choose an investmentnewsletter on the basis of longer-term returns.
Chasing One-YChasing One-YChasing One-YChasing One-YChasing One-Year Returear Returear Returear Returear ReturnsnsnsnsnsTo illustrate, I constructed a hypothetical portfolio that
exploited one-year returns. Each January 1, this portfolioinvested in the best-performing newsletter portfolio fromthe previous year. It followed this portfolio for 12 months,and then started the process all over again.
For example, on January 1, 1991, this portfolio startedfollowing the “Speculative Portfolio” of a newsletter calledYour Window Into The Future. This portfolio was chosenbecause in 1990 it produced a phenomenal 153.2% return,far outpacing the 6.2% loss of the DJ Wilshire 5000.
At the end of 1991, our hypothetical portfolio shiftedgears so that it now was following the newsletter portfoliothat did the best in 1992. This turned out to be the Op-tions Portfolio of the Granville Market Letter, which out-performed all others the HFD followed in 1992 with a gainof 244.8%. In similar fashion, this hypothetical portfolio atthe beginning of each subsequent year shifted into the pre-vious calendar year’s top performer.
Over the 14+ years from the beginning of 1991 throughAugust 31, 2005, this portfolio produced an annualized losslosslosslosslossof 24.0%! (See Table 1.)
Chasing 5-YChasing 5-YChasing 5-YChasing 5-YChasing 5-Year Returear Returear Returear Returear ReturnsnsnsnsnsIf one-year rankings do such a poor job, how about
five-year rankings? To find out, I constructed another hy-pothetical portfolio that each January 1 invested in theportfolio with the best return over the previous fivefivefivefivefive years.
Over the entire 14+ years through August 31, 2005,our hypothetical portfolio that chased the five-year returns
produced a 5.5% annualized gain. Though this is still wellbelow the return of the DJ Wilshire 5000 index, it never-theless is far better than the 24.0% annualized loss of theportfolio that chased the best one-year performers—andmodestly better than the 3.9% annualized return producedby riskless T-Bills over this period.
Chasing 10-YChasing 10-YChasing 10-YChasing 10-YChasing 10-Year Returear Returear Returear Returear ReturnsnsnsnsnsWhat about a third hypothetical portfolio that invested
in the ten-year best performers? It did even better. Over thesame 14+ years, such a portfolio gained 9.4% annualized.
These results are exactly what we should expect, if webelieve that longer track records tell us more about anadviser’s abilities than shorter ones. And they clearly do.One-year returns do not help us tell the difference betweenan adviser whose return was the result of genuine abilityand one who merely was lucky.
Short-Term Gains Are An Unreliable Guide
Other ways of accessing HFD dataHulbert InteractiveHulbert InteractiveHulbert InteractiveHulbert InteractiveHulbert Interactive
HHHHHulbert Interactive is the online research tool that gives you24-hour access to the Hulbert Financial Digest’s performance
ratings — along with the ability to run customized queries — onthe nearly 200 stock and mutual fund newsletters with more than500 recommended portfolios.
To research a particular stock or mutual fund with HulbertInteractive, you can simply enter the ticker symbol to instantlyretrieve such information as a list of which investment newslet-ters currently are holding the security, the number of those ser-vices that have recently upgraded or downgraded that security,and which other stocks in the same industry that newsletters mayalso be recommending.
Hulbert Interactive also enables you to construct a list ofthose stocks or funds that are most recommended. In constructingsuch a list, you can choose to use all newsletters the HFD follows,or a particular subgroup meeting any of a large number of filteringcriteria that you specify.
You can subscribe to Hulbert Interactive on a daily,monthly, or yearly basis. A subscription entitles you to unlimiteduse during the period for which you sign up.
As a Hulbert Financial Digest subscriber (either print oronline), you are entitled to sign up for a full year for just $99, asavings of more than 34% off the regularly yearly rate of $149.Monthly access is sold for $19 per month, while a day pass costs $9.
To take advantage of this special discount when signingup for a year ’s subscription, subscribers should go tomarketwatch.com/commerce/HulbertInteractive.asp and use cou-pon code 8SYD30. Your discount will be automatically applied.
Individual Newsletter ProfilesIndividual Newsletter ProfilesIndividual Newsletter ProfilesIndividual Newsletter ProfilesIndividual Newsletter Profiles
YYYYYou can order a customized profile for any of the nearly 200letters that the HFD follows. The cost is $25 per profile. For
immediate processing of your profile order and e-mail delivery inPDF format, go to the “Tools and Research” tab atmarketwatch.com. Alternately, you can order a profile over thephone by calling the HFD toll free at 1-888-HULBERT.
The format of the profiles you can order from the HFD issimilar to that used on pages 3 through 6 of every issue of theHFD—with one significant difference in the case of letters thatrecommend more than one portfolio. In such cases, the profilesthat appear in the HFD focus on the averageaverageaverageaverageaverage of the letters’ indi-vidual portfolios. In contrast, a customized profile for such a letterwill include, in addition to this portfolio average, charts and graphsfor each of this letter’s individual portfolios as well.
Our intent in scheduling letters to be profiled in the HFDis to include, in any 12-month period, every letter that appears inone of the scoreboards on pages 7 or 8. To see an index that showsthe issue date of the most recent HFD in which a letter was pro-filed, log onto the following page of the HFD website: http://marketwatch.com/news/newsletters/nxd.asp.
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Frequently Asked QuestionsI’m happy with my present full-serviceI’m happy with my present full-serviceI’m happy with my present full-serviceI’m happy with my present full-serviceI’m happy with my present full-servicebroker; why should I look to a newsletterbroker; why should I look to a newsletterbroker; why should I look to a newsletterbroker; why should I look to a newsletterbroker; why should I look to a newsletterfor investment advice?for investment advice?for investment advice?for investment advice?for investment advice?
If your broker is giving you enough profitableadvice to justify paying full-service brokeragerates, then by all means stay with that
broker. It may be, however, that if you were to analyzehow much you pay for the advice (which is the differ-ence between your broker’s rates and a discountbroker’s), your enthusiasm might wane. But even ifyour enthusiasm remains undiminished, you stillshould take a look at newsletters because they mayprovide you with better advice for your money, or leadyou in directions a broker is unlikely to take you.
Which is the best investment newsletter?Which is the best investment newsletter?Which is the best investment newsletter?Which is the best investment newsletter?Which is the best investment newsletter?
This crucial question is not nearly as simpleas it appears. You might just as well ask,“Who is the best lawyer or doctor?” Far more
worthwhile is the question “Which adviser is the bestfor what I want to achieve?”
Because different subscribers are striving fordifferent goals through their investing, there is no onesingle best adviser. An excellent options newsletter, forexample, is of little use to someone for whom loss ofcapital is intolerable. Advisory letters specialize invarious investment markets, and rarely will you findthat the adviser who is best at calling turns in one areais also best in another.
What will the What will the What will the What will the What will the Hulbert Financial DigestHulbert Financial DigestHulbert Financial DigestHulbert Financial DigestHulbert Financial Digestdo for me?do for me?do for me?do for me?do for me?
The HFD will help you formulate the mostuseful criteria with which to choose amonginvestment strategies, and help you locate
those services that best fulfill those criteria. Obviously,while proven performance is the single most importantfactor to consider when selecting an adviser, otherconsiderations also must be taken into account.
What is your risk threshold, for example? Howmuch of a gambler are you? Do you roll the dice andparticipate in the office pool, or are you risk averse,unable to sleep nights when an investment movesagainst you? Is your worst nightmare receiving a
How We Calculate Performance
TTTTThe HFD buys or sells a recommended security at itsclosing price on the day the HFD receives in the mail
the letter making the recommendation. If the recom-mendation is made electronically (via phone hotline, e-mail, FAX or website), it is executed at the average of thesecurity’s high and low prices in the day’s session follow-ing receipt of the recommendation. If an editor wishes atrade to occur at other prices—such as at the opening, orat limit prices—then he/she must explicitly say so.
Regardless of whether a market order is executed atthe closing or the average price, however, the HFD ad-justs that price upwards (when buying) or downwards (whenselling) according to an estimate of that security’s bid-askedspread on that day.
The HFD follows electronic recommendations only inthe event those recommendations are made available toregular subscribers at no additional charge. The HFD fol-lows telephone hotlines only in the event they are notupdated more than once per day.
The HFD debits a commission on all transactions, therate of which is based on average commissions at the nation’slargest discount brokers on average-sized transactions. (Thisrate changes periodically to reflect current conditions.) Forstocks, this rate was 1.0% each way through the end of1996; 0.75% during 1997, 0.25% starting January 1, 1998;and 0.1% beginning January 1, 2006. For options, this ratewas 3.0% each-way through the end of 1997, 2.0% begin-ning January 1, 1998; and 1.5% beginning January 1, 2006.
For futures contracts, the round-trip commission is (andhas been) 0.05% of the contract’s value. For mutual funds,loads and redemption fees are debited as appropriate.
The HFD’s calculations do not take taxes into account.However, dividends and fund distributions areareareareare credited onthe day the security goes ex-dividend.
When a newsletter’s advice is ambiguous the HFD con-structs portfolios for it. The HFD applies the same method-ology across the board for all such newsletters. For a de-tailed description of this methodology for ambiguous letters,turn to page 11.
The HFD calculates timing-only performances as fol-lows: Within each market, each timer earns the same rateof return when invested and the same rate of return whenin cash. The proxy for investing in stocks is the Dow JonesWilshire 5000’s Value-Weighted Total Return Index; forgold, London’s P.M. Fixing Price; for bonds, the ShearsonLehman All-Maturities Treasury Index; and for cash, the90-day T-Bill rate.
The timing-only performances are designed to aid, inparticular, the mutual fund switcher. Thus, in the eventan editor recommends going short on a sell signal, we cal-culate two ratings—one assuming the investor does goshort and the other assuming he goes into cash. In addi-tion, these transactions are made at the closing price onthe day subscribers are able to act on the advice. No com-missions or taxes are debited. For a full discussion of ourtiming-only ratings, turn to page 8.
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margin call, or are you willing to risk a lot in hopes ofcatching a really big winner? No amount of performancedata can decide for you what amount of risk you arewilling to incur. That is something you must decide foryourself—taking into account your age, financial status,family situation, sense of security and so forth. Onlyafter answering these questions can you pick an adviserintelligently; a top-performing letter may be inappropri-ate for you if it exceeds your risk threshold.
Another consideration is the clarity of the advicegiven. Some newsletter writers (as well as many otherpurveyors of financial advice, for that matter) are notori-ous for their ambiguous statements, talking out of bothsides of their mouths at once. Some advisers, for example,will discuss in each issue both the bullish and bearishcases for the stock market, and in the next issue quoteonly that portion that makes them look clairvoyant.Others do not provide consistent follow-up advice on thestocks mentioned in earlier issues, instead mentioningjust those that have performed the best in the interim.
The HFD specifically rates the clarity and complete-ness of the advice contained in each newsletter. This islisted under “clarity” in the Long Term PerformanceRatings table.
I once compared the I once compared the I once compared the I once compared the I once compared the HFDHFDHFDHFDHFD ratings with ratings with ratings with ratings with ratings withmutual fund performance and found thatmutual fund performance and found thatmutual fund performance and found thatmutual fund performance and found thatmutual fund performance and found thatthere were more high-performing fundsthere were more high-performing fundsthere were more high-performing fundsthere were more high-performing fundsthere were more high-performing funds
than newsletters. Why shouldn’t I just invest inthan newsletters. Why shouldn’t I just invest inthan newsletters. Why shouldn’t I just invest inthan newsletters. Why shouldn’t I just invest inthan newsletters. Why shouldn’t I just invest inmutual funds?mutual funds?mutual funds?mutual funds?mutual funds?
You still would have to decide which mutualfunds to invest in, when to invest in them, andwhen to have your portfolio in money market
funds. Many different newsletters can help you decide.In any case, comparisons between investment
newsletters and mutual funds can be misleading. Fundsare often parts of “families” of funds, and a fairer com-parison with newsletters would be with the average ofall the mutual funds within a family. With so manyfunds in these mutual fund families, it would be surpris-ing if one or another of each family of funds was not atthe top a given quarter’s or year’s rankings. But thatdoesn’t mean that those fund families possess anyparticularly special investment genius. Indeed, theparticular genius of those fund families is a marketingrather than an investment genius: Since one of theirfunds always will be at or near the top, their marketingefforts can be little more than fill-in-the-blank affairs.
Just as mutual fund families should be compared onthe basis of some average, so should those newslettersthat recommend more than one model portfolio. Newslet-ters are ranked by portfolio average in the scoreboardsthat appear on pages 7 and 8 of each monthly HFD.
Having said this, however, many newsletter subscrib-ers would do well to consider mutual funds (either theopen-end funds you see listed every day in the newspa-per or the personal mutual funds you can construct onthe web). Without substantial amounts to invest inindividual stocks, it is very difficult on one’s own to
achieve adequate portfolio diversification while keepingcommissions at low. Through purchases of mutual orpersonal funds, however, you can inexpensively achievethat diversification for as little as the minimum pur-chase amount (typically just a few thousand dollars).
I recently received lots of advertisingI recently received lots of advertisingI recently received lots of advertisingI recently received lots of advertisingI recently received lots of advertisingabout a particular newsletter that I don’tabout a particular newsletter that I don’tabout a particular newsletter that I don’tabout a particular newsletter that I don’tabout a particular newsletter that I don’tsee covered in the HFD. Is there some-see covered in the HFD. Is there some-see covered in the HFD. Is there some-see covered in the HFD. Is there some-see covered in the HFD. Is there some-
thing wrong with that newsletter that keeps youthing wrong with that newsletter that keeps youthing wrong with that newsletter that keeps youthing wrong with that newsletter that keeps youthing wrong with that newsletter that keeps youfrom following it?from following it?from following it?from following it?from following it?
There are many different reasons that couldaccount for a newsletter’s absence from theHFD Performance Ratings, so you can con-
clude nothing from that absence. Many popular newslet-ters, for example, do not provide model portfolios orsufficiently clear advice for the HFD to constructportfolios for them. So while they may be excellent atwhat they do provide (be it market commentary, philo-sophical discussions, or educational articles), the HFDcannot come up with a Performance Rating for them.
But a letter’s absence from the HFD’s rankings maysimply be due to the fact that we have not received manyrequests to follow it. The HFD chooses among the manynewsletters it could add according to the wishes of sub-scribers. The HFD tries to satisfy subscribers first. Ifyou have a particular newsletter you would like to seeadded, we invite you to let us know.
How should I use the How should I use the How should I use the How should I use the How should I use the HFDHFDHFDHFDHFD’’’’’s performances performances performances performances performancedata? Should I switch between newslettersdata? Should I switch between newslettersdata? Should I switch between newslettersdata? Should I switch between newslettersdata? Should I switch between newslettersthe way some investors switch betweenthe way some investors switch betweenthe way some investors switch betweenthe way some investors switch betweenthe way some investors switch between
mutual funds?mutual funds?mutual funds?mutual funds?mutual funds?
If new evidence develops that suggests yourcurrent letter is not for you, then by all means
you should switch to another. Similarly, if your financialsituation changes, then switching also may be in order.
But as a general rule you should not switch back andforth between newsletters as cavalierly or as frequentlyas many mutual fund switchers do between their chosenmutual funds. Once you have chosen a good newslet-ter—after checking out its long-term track record,examining its risk level and assuring yourself that it isin accord with your own—then you probably should stickwith it and give it a chance.
This isn’t to say that the newsletter you have chosenwill be the perfect one for you (as if any service can fitthat description). But the problem with constantlysecond-guessing your chosen letter (or with second-guessing any adviser, for that matter) is that you mostlikely will be tempted to second-guess at the worstpossible times. Your emotions can be your worst enemywhen investing, and the goal of a newsletter or strategyshould be to impose a discipline that helps you resistyour temptations to second-guess. As articulated in rule#4 on page 2 of this booklet, therefore, you shouldformulate a contingency plan in advance for when youwill switch from your chosen letter to an alternative.
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Risk-Adjusted Performance
RRRRRisk and risk-adjusted perfor-mance are two different things.
RiskRiskRiskRiskRisk is defined by the HFD as volatil-ity. A newsletter therefore will be de-fined as having low risk if its perfor-mance is consistent, and having highrisk if its performance exhibits dra-matic swings.
In contrast, risk-adjusted perfor-risk-adjusted perfor-risk-adjusted perfor-risk-adjusted perfor-risk-adjusted perfor-mancemancemancemancemance reports the relationship be-tween performance and risk. It an-swers the question: how well does anewsletter exploit risk?
What does this mean? Take a lookat the accompanying graph. Notice thatboth hypothetical newsletters producedprecisely the same rate of return dur-ing 1994. The only difference betweenthem is the path they followed toachieve that return. Newsletter A pur-sued an incredibly wild path, whileNewsletter B traversed a fairly steadyand consistent path.
On an intuitive level, most inves-tors understand that Newsletter B is abetter bet for future performance thanNewsletter A. Why? Because they cansee from the graph that Newsletter A’sperformance for the year was muchmore likely to have been the result ofluck alone. Ask yourself: Which
newsletter’s performance is more pre-dictable? If you were a gambler, whichwould you bet on? Since Newsletter B’sperformance is so much more steadyand consistent, most investors can im-mediately see why it should receivetheir bet.
All that the HFD’s risk adjustmentdoes is provide a numeric measure-ment of what our intuition already tellsus. It is based on what’s known as theSharpe Ratio (namedafter William Sharpe,the Nobel-prize win-ning former StanfordUniversity finance pro-fessor): In the numera-tor of this ratio is per-formance, and in thedenominator is risk orvolatility:
PerformanceVolatility/Risk
Since both NewsletterA’s and B’s perfor-mances are identical,the only difference intheir risk-adjusted per-formances can betraced to what appearsin the denominator of
this fraction. And since that is a muchlarger number in the case of Newslet-ter A (about 27 times larger, in fact),the resulting value of this fraction forNewsletter A will be correspondinglythat much lower.
Be careful not to confuse riskriskriskriskrisk andrisk-adjusted performancerisk-adjusted performancerisk-adjusted performancerisk-adjusted performancerisk-adjusted performance. Whenit comes to risk, you should want lessof it. But when it comes to risk-adjustedperformance, you should want more.
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
12/93 2/94 4/94 6/94 8/94 10/94 12/94
Newsletter A
Newsletter B
The High Price of High VThe High Price of High VThe High Price of High VThe High Price of High VThe High Price of High VolatilityolatilityolatilityolatilityolatilityBoth Newsletter A and B made the same amount of money
in 1994. Yet Newsletter B did so with much less volatilityand risk, and hence will have a much higher risk-adjusted
performance.
The Importance of Adjusting For Risk
Whether you go for an aggressiveinvestment style or a cautious one
is a matter of personal preference. Somepeople like to take risks in the hope ofeven bigger rewards. Others prefer tolimit their risks and will settle forsmaller rewards. But whether you area lion or a lamb when it comes to in-vestments, you want an investment ad-viser that justifies whatever level ofrisk he/she incurs.
Most investors fail to appreciate thiscrucial role played by risk. They tendto pick the adviser with the hottest re-cent performance. This is kind of likewalking into a poker game and bettingon the player who happens to have thebiggest pile of chips in front of him. Youdon’t know whether he won the heap ina wild gamble or whether he piled it upgradually by playing both good hands
and bad hands well.For example, consider the “Prudent
Speculator Portfolio” from a newslettercalled the Prudent Speculator, editedcurrently by John Buckingham, thoughat the time by Al Frank. Investors wereeager to sign up in the summer of 1987,since at the time this newsletter wasthe top performer among letters theHFD had followed since mid-1980: Itsmodel portfolio had beaten the DowJones Wilshire 5000 over the previousseven years, 686.4% to 274.1%. Yet thePrudent Speculator Portfolio was apoor bet for future gains, this 686.4%gain notwithstanding. To get that per-formance, it had been incurring toomuch risk.
Why was this portfolio a poor bet?Over those 7 years, it was 2 1/2 timesmore volatile, or risky, than the mar-
ket itself. To justify being that risky,the Prudent Speculator Portfolio wouldhave had to make even more than686.4%. On a risk-adjusted basis, there-fore, it was not ahead of the market.
In the 1987 Crash, the PrudentSpeculator Portfolio lost nearly 60%.Pointing out today that this portfolio wasa poor bet in 1987 is not just 20:20 hind-sight on our part, either. After report-ing in the July 1987 HFD that the Pru-dent Speculator Portfolio had not beatenthe stock market on a risk-adjusted ba-sis, I wrote: “Now is the time to be ex-tremely choosy in insisting that yourparticular newsletter makes the mostof the risk it incurs. Those newslettersthat do poorly on a risk-adjusted basiswhen the market is going up are likelyto be particularly disappointing whenthe market goes down.”
Page 7
HFD’s Risk-Adjusted NumbersThe HFD adjusts newsletters’ per-
formances for risk to give subscribersadvance warning of situations like thePrudent Speculator’s. Our risk-ad-justed ratings appear in several loca-tions, including the right-hand side ofthe scoreboards on pages 7 and 8 in eachmonthly issue.
Consider the Prudent Speculatoragain, for example. According to theHFD, its Prudent Speculator Portfoliogained 5,981% from mid-1980 throughAugust 31, 2005 (16.3% annualized), faroutpacing the 1,982% gain of the DowJones Wilshire 5000 Index (12.8% an-nualized). On a risk-adjusted basis,however, this portfolio slightly lags theDJ Wilshire 5000, having produced anaverage gain of 0.141% per month perunit of risk, in contrast to 0.142% forthe DJ Wilshire 5000.
But what does this 0.141% or0.142% really mean? The precise for-mula appears in the article at the topof page 6. In what follows, we presenta user-friendly way of understandingthese risk-adjusted ratings.
Imagine comparing each letter toan index fund portfolio whose risk levelhas been increased (through the useof leverage) or decreased (by mixing itwith cash) to match the newsletter’s.Only if the newsletter does better thanthis adjusted index fund has it beatenthe market on a risk-adjusted basis.
Graph I tothe right pre-sents this com-parison in thecase of the Pru-dent SpeculatorPortfolio. On araw, unadjustedbasis from mid-1980 throughAugust 31, 2005,this portfoliogained a cumula-tive total of5,981% (16.3%a n n u a l i z e d ) .(This portfolio’sperformance isrepresented bythe heavier linein the graph).Over this 25+year period, fur-thermore, thisletter’s portfolio was nearly 2.4 timesriskier than the stock market itself.The fainter line on the graph showshow an index fund would have per-formed had it been bought on enoughmargin that its risk was the same asthe Prudent Speculator Portfolio. Asyou can see, this adjusted index fundportfolio beat the Prudent SpeculatorPortfolio, gaining over 6,332% (17.9%annualized). Thus, on a risk-adjustedbasis, the Prudent Speculator Portfo-
lio didn’tdidn’tdidn’tdidn’tdidn’t beatthe market.
This is whyadjusting per-formance forrisk is so im-portant. If wewere not to doso, we wouldconclude thatthe PrudentS p e c u l a t o rPortfolio addedvalue, since itbeat the mar-ket over thisperiod by awide margin.Yet that leadover the mar-ket was due tothe asusmptionof a lot of risk. There are
Graph II. DJ Wilshire 5000 vs. De-LeveragedPrudent Speculator Portfolio*
When the effect of the newsletter’s high risk is removed,it under-performs the market.
* The Prudent Speculator Portfolio leveraged downward tomatch the volatility of the market.
Graph I. The Prudent Speculator Portfolio vs.Leveraged Index Portfolio*
If you were willing to incur as much risk as the Prudent Spec-ulator Portfolio, you could have made more with an index fund.
*The Dow Jones Wilshire 5000 leveraged upward to match thevolatility of The Prudent Speculator Portfolio.
other ways of understanding this ap-proach to risk adjustment. Another isjust the flip side of the first: Instead ofleveraging an index fund upwards upwards upwards upwards upwards inorder to match the Prudent SpeculatorPortfolio’s volatility, we can leveragethe Prudent Speculator Portfoliodownwards downwards downwards downwards downwards so that its volatilitymatches the stock market itself. To doso, we have to construct a portfolio thathas just the right allocation to the Pru-dent Speculator Portfolio (keeping therest in T-Bills) so that the resultantmixture has the same volatility (orrisk) as the market.
This approach is illustrated inGraph II. As before, the PrudentSpeculator Portfolio’s performance isrepresented by the bolder line, whilethe stock market by the fainter line.Once again, after adjusting for risk,the stock market came out ahead.
Both the first and second ap-proaches reach the same conclusions.Our advice: focus on whichever ap-proach enables you best to make senseof risk adjustment.
We now have an answer to whatthe HFD means when it reports thatthe Prudent Speculator Portfolio’s risk-adjusted performance over the last 25+years to have been 0.141% per monthper unit of risk, vs. 0.142% for the DJWilshire 5000. This is simply a numeri-cal representation of what you see plot-ted in Graphs I and II.
Page 8
TTTTTo illustrate what’s included in, andwhat questions can be answered by,
the HFD’s Timing Scoreboard, considerthe following parable. Imagine that youare looking for a good market-timing news-letter, and are choosing between two ad-visers named Midas Timer and MidasPicker. Assume further that the modelportfolios of both have been equally prof-itable. On performance grounds alone,thus, there would appear to be no basisfor deciding which of the two of them wouldbe a better bet as a market timer.
In fact, however, Midas Timer wouldbe a much better bet for timing the mar-ket: He has a “Midas Touch” when it comesto picking the market’s tops and bottoms.Unfortunately, however, Mr. Timer’s“Midas Touch” does not extend to pickingindividual stocks or mutual funds. Thoseindividual picks are so dismal, in fact, thathe loses the benefit his great timing oth-erwise would provide him. Hence, hismodel portfolio’s performance has beenmediocre.
Contrast the experience of Mr.Timer with Midas Picker, who is a mirrorimage of Mr. Timer: Mr. Picker has a“Midas Touch” when it comes to pickingindividual stock and mutual funds but hasno ability to time the market. In fact, hisstock selection abilities have been goodenough to overcome the effects of his badtiming; but just as with Mr. Timer, hisbad timing counteracts his great stock andfund selections to cause his portfolio’s per-formance to be merely mediocre.
None of this would be obvious,however, from an investigation of theirrespective Performance Ratings. Bothwould appear to be equally good bets, sincethey made exactly the same amount ofmoney. Some additional measurementsare needed to pinpoint which has been thebetter market timer.
The Timing ScoreboardThe Timing ScoreboardThe Timing ScoreboardThe Timing ScoreboardThe Timing ScoreboardIt is precisely for these reasons
that the HFD created a TimingScoreboard. Imagine how well you mightdo if you looked to Midas Timer for justtiming advice, ignoring his dismal stockand mutual fund selections.
The HFD’s Timing Scoreboardallows you to focus on Midas Timer’s greattiming. It extracts the pure timing compo-nent from Midas Timer’s advice, and mea-sures just that. The Timing Scoreboarddoes this by constructing hypotheticalportfolios for each adviser that are identi-cal to those advisers’ model portfolios—except for one crucial difference. Every timethey recommend that their model portfo-lios purchase or sell individual stocks or
funds, the hypothetical portfolios con-structed for purposes of the TimingScoreboard buy or sell a comparable dol-lar amount of the Dow Jones Wilshire5000 Total-Return Index (which is the in-dex the HFD uses as a proxy for the stockmarket as a whole).
Let’s return to the parable of thetwo Midas advisers to illustrate. WhenMidas Timer recommends that subscrib-ers become 100% invested in a particularbasket of stocks and mutual funds, theTiming Scoreboard becomes 100% in-vested in hypothetical shares of the DJWilshire 5000. So when the market sub-sequently goes up (as it inevitably doeswhen Midas Timer recommends buying),this hypothetical portfolio goes up too—even though Mr. Timer’s specific modelportfolio is languishing due to his dismalstock and mutual fund picks.
Likewise, a hypothetical portfo-lio is constructed to measure the timingof Midas Picker, going into and out ofshares of the DJ Wilshire 5000 index ashe recommends buying and selling indi-vidual stocks and mutual funds. Thus, eventhough those individual picks help to res-cue the performance of Mr. Picker’s spe-cific model portfolio, they have no effecton the performance of the hypotheticalportfolio constructed for the HFD’s Tim-ing Scoreboard. This latter portfolio showsup Mr. Picker’s poor timing for what it is.
After all is said and done, howwill these two advisers perform on a Tim-ing-Only basis? Midas Timer will beranked at the top and Midas Picker willbe ranked at the bottom. And you will beable to go straight to the adviser who hasa great record at timing the market, andavoid the one who doesn’t.
Stockpickers and Timing-Stockpickers and Timing-Stockpickers and Timing-Stockpickers and Timing-Stockpickers and Timing-Only RatingsOnly RatingsOnly RatingsOnly RatingsOnly Ratings
By the same token, the TimingScoreboard helps us to identify those ad-visers who are like the “Midas Picker” inthe above parable. All we have to do iscompare the performance of a letter’smodel portfolio with its timing-only rat-ing. If its model did better, then you canconclude that its recommended stock andfund selections outper-formed the market.
Take a look atthe chart at right,which reports the per-formances of two news-letters through 8/31/05. For each newslet-ter, you’ll find the per-formances both of its
model portfolio as well as of its hypotheti-cal timing-only portfolio.
The question to ask yourself:which of these newsletters has been bet-ter over these 25+ years at picking securi-ties that would beat the stock market?The answer: Growth Stock Outlook. Why?Because GSO’s model portfolio outper-formed its corresponding timing-only port-folio. That means that GSO’s recom-mended stocks outperformed the DJWilshire during the times they wereowned.
In contrast, the securities ownedby the “Nearer Term Trading Portfolio” ofThe Dines Letters lagged the market. Howdo we know that? Because we can see fromits corresponding timing-only portfoliothat if its securities had done as well asthe DJ Wilshire 5000, then the portfoliowould have performed better (10.2% an-nualized, instead of 0.3%).
The Timing Scoreboard andThe Timing Scoreboard andThe Timing Scoreboard andThe Timing Scoreboard andThe Timing Scoreboard andMutual Fund InvestorsMutual Fund InvestorsMutual Fund InvestorsMutual Fund InvestorsMutual Fund Investors
The parable of the two Midas’sillustrates most of what you need to knowabout HFD’s Timing Scoreboard. A fewdetails remain to be discussed, however.
The most important additionaldetail you need to keep in mind is that theTiming Scoreboard is designed first andforemost to help the mutual fund inves-tor. On the assumption that most of thoseinterested in these calculations use no-load or very-low-load funds, the calcula-tions did not charge commissions. If youare using a market timer to trade stocksor other securities for which commissionscan be a significant factor, therefore, youshould adjust these figures accordingly.
Another consequence of designingthe Timing Scoreboard for the mutualfund investor concerns short selling. Upuntil very recently, there has been no pos-sibility of such an investor actually goingshort the market. Instead, fund switchershave had to go into cash upon receiving asell signal from whatever adviser or tim-ing system they were using. This con-fronted the Timing Scoreboard with a new
The HFD’s Timing Scoreboard
continued at bottom of page 9
Timing-Only Gains Through 8/31/2005Timing-Only Gains Through 8/31/2005Timing-Only Gains Through 8/31/2005Timing-Only Gains Through 8/31/2005Timing-Only Gains Through 8/31/2005
Page 9
Newsletters’ Most Popular Stocks
wrinkle, since some of the advisers advo-cate actually going short the market uponreceipt of a sell signal. To deal with thiswrinkle, the HFD constructs two differentTiming Scoreboard portfolios for thoseadvisers who actually recommend goingshort. The first of the two goes short inshares of the DJ Wilshire 5000 upon re-ceipt of a sell signal, while the second—mimicking the typical mutual fund inves-tor—instead goes into cash. This explains
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Over subsequent month Over subsequent year
TTTTThe one question that subscribers askperhaps more than any other concerns
the performance of newsletters’ mostpopular stocks. Our response often is tofirst ask them another question: What dothey think? Is popularity a virtue or a vice?
HFD subscribers are almostevenly divided on this question. On theone hand, some argue that a stock mustbe a particularly good bet if it impressesso many newsletter editors. On the otherhand, others are convinced that thesestocks ought to be avoided—on the theorythat they must be highly priced and over-valued by the time lots of newsletter sub-scribers have bought them.
Clearly, intuition isn’t going tohelp us discover whether newsletters’ mostpopular stocks ought to be sought orshunned. Fortunately, several years agothe HFD researched the matter.
The HFD’s StudyThe HFD’s StudyThe HFD’s StudyThe HFD’s StudyThe HFD’s StudyThe HFD exhaustively studied
newsletters’ most popular stocks over 16years. Our study took from each month’sissue of the HFD the group of stocks thatwere recommended by the most newslet-ters. If there were fewer than five in thiscategory, then we took stocks from the nextmost highly-recommended category. Thus,for each month between November 1980(which is when the HFD first began pro-viding this information) and April 2006,we came up with at least five stocks thatwere recommended more often than anyothers. All told, this involved 2,119 stocks.
We chose to define popularity inthis way because the criteria for being“most popular” has changed over theyears. Because we were following onlyabout a fourth as many newsletters in1980, it was rare for a stock to be recom-mended by more than two or three letters.Today, in contrast, it’s not unusual for tenor more letters we track to recommend thesame stock at the same time.
The HFD measured the perfor-
mance of these 2,119 stocks over two peri-ods. The first was the subsequent month,since that is how often the HFD is pub-lished and how often subscribers wouldbe able to find out whether a stock contin-ues to be among the most popular. Thesecond measurement period was the sub-sequent 12 months. Both the monthly andthe yearly returns were then compared tothat of the Dow Jones Wilshire 5000’sValue-Weighted Total Return index.
The results? Over the subsequentmonth following their elevation to most-popular status, these stocks outperformedthe stock market by a margin of 10 basispoints. Over the subsequent year, theyoutperformed the DJ Wilshire by 62 ba-sis points. (See chart below.)
How significant are these re-sults? On the one hand, these margins arenot large enough to make up for transac-tion costs. Assuming 0.5% one-way trans-action costs, for example, you wouldn’t havebeaten the market by buying and sellingthese stocks. On the other hand, therearen’t contrarian grounds for avoiding let-ters’ most-popularstocks.
Neverthe-less, there are othersituations in whichnewsletters’ mostpopular stocks maybe more attractive.Let’s say that youhave decided forother reasons to in-vest in the stockmarket, and thusare going to be in-curring transactioncosts anyway. Or,alternately, youmay be looking tosell some of yourstocks in order toreduce yourportfolio’s market
The Average Amount By Which Newsletters’The Average Amount By Which Newsletters’The Average Amount By Which Newsletters’The Average Amount By Which Newsletters’The Average Amount By Which Newsletters’Most Popular Stocks OutperMost Popular Stocks OutperMost Popular Stocks OutperMost Popular Stocks OutperMost Popular Stocks Outperforforforforformed the Dowmed the Dowmed the Dowmed the Dowmed the Dow
Jones Wilshire 5000 (11/1980 to 4/2006)Jones Wilshire 5000 (11/1980 to 4/2006)Jones Wilshire 5000 (11/1980 to 4/2006)Jones Wilshire 5000 (11/1980 to 4/2006)Jones Wilshire 5000 (11/1980 to 4/2006)
exposure. In both cases, the HFD’s list ofletters’ most popular stocks would be agood place to start in your decision-mak-ing process.
In any case, we need to keep inmind that, over time, around 80% of alladvisers’ portfolios underperform themarket. Merely to equal the market’s re-turn thus places a strategy at the 80thpercentile. The HFD’s study thus suggeststhat newsletters’ most popular stocks per-form better than the average newsletter.
ConclusionConclusionConclusionConclusionConclusionAt a minimum, therefore, the
HFD’s study confirms there is no reasonto avoid a stock simply because it enjoysimmense popularity among newsletters.In some circumstances, furthermore, suchpopularity might actually be a reason totake a second look at a particular stock.
Let me end with a disclosure note:the HFD is not an investment adviser.Neither the appearance of a stock in thelist of newsletters’ most popular stocks,nor its subsequent removal, constituteseither a buy or a sell signal by the HFD.
why the Timing Scoreboard contains tworatings for some advisers’ timing systems:one that goes short on sell signals and theother that goes into cash on sell signals.
Gold and Bond TimersGold and Bond TimersGold and Bond TimersGold and Bond TimersGold and Bond TimersThe above discussion of market
timing has focused exclusively upon thestock market. But in recent years therehas been a growing interest in timing thebond and gold markets as well. To respondto this interest, the HFD expanded itsTiming Scoreboard to measure timing inthese sectors as well.
The principle behind these addi-tional sections of the Timing Scoreboardis the same as that underlying the stockmarket portion. The sole difference wasthe proxy used for the “market.” For stockmarket timing, as mentioned above, theHFD used the DJ Wilshire 5000. For theGold Timing Scoreboard, the HFD usesthe London P.M. Fixing Price, and for bondsthe Shearson Lehman Treasury Index (atotal return index, taking into account allU.S. Treasury securities with maturitiesgreater than one year).
continued from page 8
Page 10
The HFD’s Sentiment Indices
OOOOOne of the ancillary benefits the HFDderives from tracking hundreds of in-
vestment newsletter portfolios is the abil-ity to derive a consensus judgment amongthose advisers about where the variousfinancial markets are headed. Of course,never will every newsletter editor be bull-ish, nor a time when they’ll all be bearish.But there will be times when the editors,on balance, are more bullish than at oth-ers.
The HFD calculates the consen-sus of investment newsletter editors’ opin-ions by averaging the percentage marketexposure among all of them who providespecific allocation advice. To illustrate,let’s assume that the HFD follows justtwo newsletters, and that one recom-mends that its subscribers be 100% in-vested in stocks and the other recommendssubscribers be just 50% invested in equi-ties (keeping the other 50% in cash). Insuch an event, the HFD would report anaverage market exposure of 75%.
Most investors who focus on ad-visory sentiment interpret the data in acontrarian fashion. That is, they do theopposite of the consensus, especially whenthat consensus approaches an extreme:They become more bullish as advisors onbalance become excessively bearish, andvice versa.
Because the HFD is not an invest-ment advisor, we cannot advise you on anyparticular investment strategy for usingthe HFD’s advisory sentiment data. How-ever, we can report a number of character-istics of the historical data. And there issupport in the data for the notion that ad-visers become more bullish as the marketapproaches peaks and become more bear-ish as the market declines.
Take alook at the graphin the upper rightcorner of this page.It plots advisers’average equity ex-posure over thelast 25+ years, aswell as the DowJones Wilshire5000. Notice, forexample, how sen-timent grew morebearish after theCrash of 1987, aswell during someparts of the bearmarket that beganin 2000. Similarly,notice how senti-ment tends to be-come more bullish as the stock marketrises.
A warning, however: the inversecorrelation between these two data seriesisn’t perfect. So you can’t interpret theHFD’s stock newsletter sentiment indexin any mechanical way. Notice, for ex-ample, that the peak of advisorybullishness over the last 25 years occurredin early 1985, which—as is illustrated inthe accompanying graph—was not a badtime at all to be invested in equities. Andyet knee-jerk contrarians who automati-cally do the opposite of the consensuswould have been out of stocks altogether.
By the way, the HFD also calcu-lates similar advisory sentiment indicesfor the NASDAQ, gold and bond markets.The latter two of these sentiment indicesare plotted in the charts at the bottom ofthis page. In general the same things can
Advisers’ Stock Market ExposureAdvisers’ Stock Market ExposureAdvisers’ Stock Market ExposureAdvisers’ Stock Market ExposureAdvisers’ Stock Market Exposure
Advisers’ Gold Market ExposureAdvisers’ Gold Market ExposureAdvisers’ Gold Market ExposureAdvisers’ Gold Market ExposureAdvisers’ Gold Market Exposure Advisers’ Bond Market ExposureAdvisers’ Bond Market ExposureAdvisers’ Bond Market ExposureAdvisers’ Bond Market ExposureAdvisers’ Bond Market Exposure
be said about these data as for the stocksentiment data.
Ordering the HFD SentimentOrdering the HFD SentimentOrdering the HFD SentimentOrdering the HFD SentimentOrdering the HFD SentimentIndicesIndicesIndicesIndicesIndices
The HFD’s four different advisorysentiment indices appear in each issue ofthe HFD, updating their values as of theclose of the previous month. Thus, for ex-ample, the July HFD updates these threeindices as of the end of June.
The HFD actually updates theseindices daily, however. If you wish, you canpurchase these data from the HFD, whichwill be e-mailed directly to you on either adaily or a weekly basis If you’re interestedin a subscription to any or all of these sen-timent indices, call the HFD at the num-ber listed on the front page of this book-let. Alternately, you can e-mail JohnKimble at [email protected]
Page 11
Methodology Used To FollowAmbiguous AdviceBy definition, when a newsletter�s ad-
vice is ambiguous, it is impossible toascertain every last detail of the portfoliosthe advisers want their subscribers to con-struct. To deal with each case of ambiguityimpartially (since the HFD has no stakein one or another letter doing well), the HFDset down in advance rules that would befollowed automatically in the event a news-letter was silent or vague about this or thataspect of constructing a model portfolio.
You should realize, however, that thereis no one right way for a subscriber to dealwith vague and ambiguous investment ad-vice. One of the inevitable consequences ofambiguity is that different subscribers,each faithfully following such advice, nev-ertheless may invest their portfolios inquite different ways�with accordingly dif-ferent results. To the extent you would haveinterpreted a newsletter�s advice differ-ently than did the HFD, your results wouldvary from those the HFD publishes. Sincethere is no one correct way to deal withambiguities, you shouldn�t assume theHFD�s resolution of them is the only waythat could be chosen by fair and reason-able people.
This is not to say that the methodol-ogy chosen by the HFD is unfair orunrevealing, however. On the contrary, itis eminently fair. Furthermore�and thisis crucial�the HFD applies this method-ology across the board.
The HFD’s Rules
Most of the HFD�s rules come into playonly in the event a newsletter�s ad-
vice in some way is silent or vague. If itclearly and unambiguously deals with allaspects of translating its advice into a port-folio, then the HFD follows that advice.Instead, the HFD�s rules apply primarilyto letters with some ambiguity in their ad-vice�that is, letters rated �B� or �C� for clar-ity in the HFD�s Long Term PerformanceRatings.
Not surprisingly, most of the lettersthat have been most upset with their HFDratings over the years have to some degreebeen unclear or incomplete in their advice.Why is this not surprising? Because if itweren�t for that lack of clarity or complete-ness, there would be no doubt as to whatthose advisers would have their subscrib-ers do�and no doubt about how muchmoney would have been made or lost. Thenext time an adviser questions the HFD�stracking of a letter�s advice, remember onething above all else as you read what thatadviser has to say: the ambiguities in theiradvice do not have to exist. If an editor dis-agrees with the HFD�s interpretation of his
advice, then all he or she need do is say�clearly and unambiguously�what a sub-scriber is supposed to do.
What are the rules the HFD followswhen dealing with ambiguous advice? Ba-sically, the HFD constructs portfolios fornon-model-portfolio letters that have thefollowing characteristics, unless the news-letter advises specifically to the contrary:
1. is fully invested;2. employs no margin;3. gives equal weight to each position;4. includes just those securities most
highly recommended at any giventime.
If an editor wants to have a certain per-centage of subscribers� portfolios out of themarket and in cash, wants the model port-folio to be margined, or wants unequal al-location of the portfolio between its vari-ous components, and so on, then the HFDrequires the editor to say so specifically.
Lies, Damn Lies, and Statistics
Implicit in this approach is that the HFDtakes a �total portfolio� approach to rat-
ing newsletters. In other words, the HFDbelieves that the best way to measure anewsletter�s performance is by trying to de-cide how much to keep in cash, what weightto give to each position, and so on. To put itanother way, it is not enough to say �theaverage recommendation of newsletterABC gained X%.� Such a statement doesnot take into account the fact that asecurity�s weight in a portfolio is a crucialfactor in newsletter performance. How astock behaves when there are only 10stocks in the portfolio should have a differ-ent impact than how it behaves when thereare 100 stocks in a portfolio.
This is a crucial point about how sta-tistics can be misleading, which an ex-ample can help illustrate. Let us supposethat a $10,000 portfolio starts out the yeardivided equally between two investments,each of which lose 10% of their value (or$500 each) before being closed out. Theportfolio now is worth $9,000. Supposenext that the portfolio becomes half in-vested in a stock that gains 10%. Ignoringinterest earned on the portion kept in cash,the portfolio now is worth $9,450.
If this portfolio�s adviser simply re-ported the average percentage gain or lossof his recommendations, he would tell youthat he lost 3.33% (the average of two 10%losses and one 10% gain). But in fact theportfolio is worth just $9,450, which is 5.5%less than its $10,000 starting value. Whilethe discrepancy between 3.3% and 5.5%may not seem huge, imagine the distor-tions created in a many-stock portfolio
with many transactions over a year�s time.When you total up your gains and
losses at the end of the year, it is in termsof your actual portfolio: you have gained orlost in real dollars. It is only fair that news-letters be judged similarly.
Rebalancing
Also implicit in the rules listed aboveis that the hypothetical portfolios set
up by the HFD to track non-model-portfo-lio newsletters enter into transactions thatno one subscriber to a newsletter is likelyto undertake. To understand the need forthese additional transactions, consider aservice which recommends purchasing anew stock without also selling a currently-held position. Where are you to get themoney to buy the new stock? Undoubtedly,each subscriber will deal with this ques-tion differently, some selling out this orthat security, some selling out partial po-sitions in several securities, and some de-ploying new amounts of cash not previouslyinvested according to the advice of this par-ticular newsletter. Taking these varioussubscriber responses into account, whatportfolio weight will the new recommen-dation have relative to other securities inthe portfolio?
The least arbitrary response to thisquestion is to assume that the new recom-mendation will have the same weight inthe portfolio as the other securities in thatportfolio (unless the newsletter specificallyadvises to the contrary). Therefore, afterbuying the new recommendation, the HFDundertakes a number of rebalancing trans-actions so that thereafter all securities inthe portfolio enjoy equal weight. Thismeans that if a stock has gained enough invalue to have greater-than-equal weight, aportion of it is sold to bring it back intoline with the others. And if a stock has de-clined in value so that it has less-than-equal weight, more shares are purchasedto bring it back to the same weight as oth-ers. (Commissions are not charged on re-balancing transactions).
New vs. Old Subscribers
One way of thinking about the HFD�sresponse to the above issue of rebal-
ancing is to take the perspective of a newsubscriber to the newsletter in question.Confronted with a list of recommended se-curities, the new subscriber intent on fol-lowing the newsletter�s advice will dividehis or her assets equally among them�regardless of whether one of those recom-mendations is a newly-rated �buy� thatwas unaccompanied by a �sell.� The port-folio constructed by the HFD for this let-
Page 12
ter, after undertaking the various rebal-ancing transactions, will look just like theone constructed by the new subscriber. Ingeneral, other things being equal, the port-folios constructed by the HFD for non-model-portfolio letters will look like theones constructed by new subscribers.
The different perspectives of the newand old subscriber also come into focus inthe HFD�s treatment of �buy� and �hold�ratings. As pointed out above, the HFD con-structs portfolios for non-model-portfolioletters out of those securities most highlyrated by them. This means that if 50 stocksare on a recommended list, and of them 25are rated �buy� and 25 are rated �hold,�the portfolio the HFD constructs will in-clude just the 25 �buys.� And when a stockis downgraded from a �buy� to a �hold,� theHFD�s hypothetical portfolio will sell thatstock. (The only exceptions to this rule comeif and when a newsletter specifically saysthat their stocks rated �hold� are just ashighly recommended as their stocks rated�buy,� in which cases the HFD�s portfoliosinclude both the �buys� and the �holds.�)
The HFD�s orientation towards thenew-subscriber perspective helps to ex-plain this treatment of �hold�-rated secu-rities. A new subscriber presumably willbuy just those securities rated �buy,� whilelonger-term subscribers may or may notown the securities rated �hold��depend-ing upon the length of time they have beensubscribers and if they were following thenewsletter�s advice at the time those secu-rities were rated �buy.� How long shouldthe HFD carry a �hold�-rated stock in aportfolio that is supposed to be represen-tative of a wide variety of subscribers?Should we automatically sell it if it hasn�tbeen mentioned as a �buy� within, say, thelast three months? Or should we wait sixmonths or a year? Rather than legislatean arbitrary cutoff for selling �hold�-ratedsecurities that have been held for a certainperiod without an intervening �buy� rec-ommendation, the HFD instead takes theperspective of the new subscriber and con-structs the portfolios out of just the �buy�-rated securities.
To illustrate the pitfalls that wouldawait the HFD if it were not to treat �hold�in this way, consider a letter that on Janu-ary 1, 1980, recommended IBM as a �buy.�Assume further that it downgraded IBMto a �hold� on February 1, 1980, and hascarried it as a �hold� in every issue up tothe present. How many subscribers to thatletter would have this stock in their port-folios today? If they faithfully followed theletter�s advice, only those who were sub-scribers during January 1980 would ownit. For all other subscribers, the perfor-mance of IBM is irrelevant.
Replies to the Skeptics
Over the years the HFD has heard anumber of objections to its treatment
of �hold�-rated securities, and you shouldbe aware of the HFD�s response. In thatway you will know how to respond if andwhen particular newsletters use these ob-jections as a way of dismissing their HFDperformance ratings.
One criticism of the HFD�s treatmentof �holds� is, simply, that �hold� means holdand not sell. But the point to bear in mindis that �hold� is ambiguous, and that thereis no way of avoiding treating �hold� assomething other than hold. To say that�hold� means hold misses the point, whichis that hold�s meaning itself is not clear.
Consider, for example, the conse-quences to new subscribers of deciding, incontrast to the HFD, that a �hold� shouldbe treated as a �buy.� It would entail hav-ing them buy all of a letter�s recommenda-tions, the �holds� as well as the �buys.�But if �hold� doesn�t mean sell, then whyshould it mean buy? Is a �hold� a �buy� or a�sell?� It can�t be both. The HFD�s criticson this issue have resolved nothing withtheir suggested �solution.�
Another objection to the HFD�s treat-ment of �holds� is that it causes Perfor-mance Ratings for newsletters to be lowerthan otherwise. Howard Ruff of The RuffTimes articulates this objection as follows:�If I recommended Squibb as a buy at 64,and made it a hold at 70 until it reached90, Hulbert�s program would close me outat 70.� But Ruff�s criticism fails to focus onwhat the HFD does when, to use his ex-ample, Squibb is downgraded to a �hold�and is sold. The proceeds are not stuffedinto a mattress, thus preventing Ruff frommaking more profits. Instead, the HFD re-invests the proceeds into stocks Ruff israting more highly at that time. This iscrucial to understand. The HFD�s approachhas the effect of keeping Ruff�s portfolioinvested in nothing other than the securi-ties he�s most highly rating.
An example from Ruff�s own use of�buy� and �hold� illustrates this importantpoint. In November 1988, after severalmonths of highly recommending severalAustralian investments, Ruff�s enthusiasmlessened. Explaining that �The Aussie dol-lar could slide if the greenback rallies� andconceding that he wasn�t �convinced theU.S. dollar bull market is over,� Ruff down-graded his recommendation on his Austra-lian investments from �buy� to �hold.�
Consider, thus, what happened toRuff�s portfolio when the HFD reorientedit out of these Australian investments intothe other securities that Ruff liked betterat that time. It was putting Ruff�s best footforward. The only way that the HFD�s treat-ment of his portfolio could cause his per-formance to be worse would be for his Aus-tralian investments to perform better whilerated �hold� than the securities he rated�buy.� But if that is the case, Ruff shouldn�thave downgraded them to a �hold� in thefirst place. The finger of blame should notbe pointed at the HFD in such a case. It
was he, not the HFD, that believed thatthese Australian investments had lesspotential and therefore should be down-graded to a �hold.�
What is true for Ruff is true for all thenon-model-portfolio newsletters. In gen-eral, the HFD�s approach to �buy� and�hold� would reduce a newsletter�s perfor-mance only in the event its recommenda-tions performed better while rated �hold�than while rated �buy.� But why shouldthat be the case? It is not the HFD, but thenewsletters themselves, that have chosento downgrade stocks to �hold.� It is theireditors who have decided that other stocks,rated �buy,� are better bets than thosedowngraded to �hold.� The HFD is takingthem at their word.
Further Replies to Skeptics
Another criticism the HFD has receivedover the years concerns the issue of
rebalancing. (As discussed above, for non-model-portfolio letters these rebalancingtransactions entail selling off small por-tions of a portfolio�s better performers andbuying more of a portfolio�s poorer perform-ers.) Most commonly, editors have articu-lated their objection to this practice by ar-guing that it violates the cardinal rule to�let your profits run.� Of course, there isanother investment cliché that runs: �Buylow, sell high��and which is directly con-tradictory to these editors� cardinal rule.But the point is not which cliché is best;rather the point is that rebalancing is ne-cessitated by ambiguous advice. If editorswant to let their subscribers� profits run,all they have to do is say so.
Consider the case of a letter that, justprior to the 1987 crash, was recommend-ing that 5% be invested in out-of-the-money puts. Because of the Crash, ofcourse, those puts skyrocketed; by mid-No-vember, in fact, when this letter�s next is-sue appeared, they represented nearly 50%of the portfolio�s value. What was a sub-scriber to do upon reading in that new is-sue, �continue to have 5% of your portfolioinvested in put options�? Should he sell offthe bulk of those put options to bring theirpercentage weight back down to 5%? Or doesthe adviser want the subscriber to continueto hold what was originally 5% but is now50%? A case could be made for either courseof action. Ambiguity has struck again.
Some letter editors, recognizing thisambiguity, have clarified their advice.They�ll tell their subscribers, for example,that their puts which originally represented1% of their portfolio now represent 5% ofthe portfolio, or whatever. If that is tooheavy an investment in those puts, theseadvisers then would sell off a portion ofthem. Similar options for clarifying theiradvice are open to any adviser, of course.All they must do is say in their newslet-ters what they mean�and not keep theHFD (or their other subscribers) guessing.
