If You Want His Advice . . .

By RUSS WILES

Jan. 6, 1998 12 AM PT

Russ Wiles is a mutual fund columnist for The Times. He can be reached at russ.wiles@pni.com

When people need personalized investment help, most turn to brokers, financial planners and money management firms. When they want another opinion, they consider the recommendations of one or more of the several hundred newsletters that aim to supply investment tips and market commentary for a broad audience.

There are newsletters covering every kind of market--stocks, bonds, mutual funds, precious metals, options. Most have sprouted in the last 15 years, and many appeal to the do-it-yourselfer who wants help but would rather not reveal his or her financial secrets to a professional.

Newsletters typically deliver their advice monthly in four to 20 pages, and many are supplemented by telephone “hotlines” subscribers can dial to get breaking advice. Investors pay anywhere from $35 to $300 or so a year to subscribe, but most publishers will send a sample issue on request for free or for a small charge.

Most newsletters provide enough information to allow readers to build and maintain a portfolio on their own. But in a few cases, the publishers are also professional money managers who, for a fee, are happy to manage their readers’ portfolios directly. In fact, some of the newsletters are more promotional device than anything else.

Unlike stockbrokers, say, or mutual fund managers, newsletter publishers are largely an unregulated lot. You don’t need any educational or work-related credential to start a newsletter, and you don’t need to pass any tests. You can base your advice on anything--one well-known newsletter uses astrology to predict the stock market’s path. And you can spout off on just about anything you want. Some publishers frequently pepper their pages with discussions having little to do with investing, taking in anything from biblical passages to social commentary.

As might be expected, then, the quality of advice rendered varies considerably, as do performance claims, the clarity of writing, and more. Investors should be aware that certain newsletter publishers are among the investment field’s most aggressive self-promoters, touting themselves at trade shows, in mass mailings and elsewhere. Caveat emptor applies here as much as anywhere else in the financial realm.

However, since 1980, Mark Hulbert has been keeping a skeptical eye on newsletters’ performance claims with, yes, a monthly newsletter of his own. His Hulbert Financial Digest monitors about 500 newsletters, and also offers related material, such as reviews of newsletters or articles challenging advertising campaigns.

Hulbert also writes a regular column on investment advisors for Forbes magazine, and he has a Web site (https://www.Hulbertdigest.com) that provides basic information on newsletters.

Hulbert’s passion has made him a newsletter expert. He spoke recently with The Times about his efforts:

Times: What prompted you to start a tracking service for investment newsletters?

Hulbert: I started the firm soon after graduate school. I was writing a book [and] . . . one of the people I wanted to interview was attending an investment conference in New Orleans in 1979. It was my first exposure to this industry. One newsletter editor after another would parade across the stage and talk about how good his track record was and how much money you’d have made by following him. I thought it would be great to have a service that actually kept track of these guys’ records. They could not all be telling the truth because they were contradicting one another.

Times: How many investment newsletters are there, and how many do you track?

Hulbert: It’s hard to give an exact number because it’s partly a definitional matter. For example, a lot of brokers send out tip sheets for clients. Are those newsletters? I don’t define them as such.

I’d say about 500 newsletters are sold for hard subscription dollars [that is, sold on their own and not included with some other kind of purchase] and count more than a handful of subscribers. We track 160. Most of the rest don’t have a model portfolio, or they don’t offer sufficiently clear advice for us to construct one for them.

Times: How does the ratings system work?

Hulbert: If a newsletter recommends a model portfolio of securities, we use it to evaluate the newsletter.

But if no model portfolio exists, we have to construct one for that newsletter. We construct it out of those securities with the highest ratings at that time. For example, if a newsletter lists 50 stocks as a “buy” and 50 as a “hold,” we’ll construct the portfolio out of the 50 buys. So when a stock is downgraded from a “buy” to a “hold,” we sell the stock from the model portfolio.

Basically, our approach tries to put a newsletter’s best foot forward. Some newsletters don’t even use the words “buy” and “hold,” but the same principle applies.

For example, [the stock monitoring service] Value Line, which has a good long-term record, grades stocks on a scale from 1 to 5. Presumably, stocks rated 1 would be buys and stocks rated 2 would be holds, so we construct a portfolio of the former.

This assumption has been controversial over the years. But if a newsletter doesn’t think we are constructing a portfolio in a way that reflects its advice, we invite them to state in the newsletter how subscribers should translate their advice to build a particular portfolio. When they do that, we do so as well.

Times: And if a newsletter has more than one model portfolio--for aggressive and conservative investors, for example--you’ll track both?

Hulbert: That’s right. And when we rank the newsletter, we’ll use a composite of the performances of the various portfolios. The reason we do that is we don’t want to give multiple-portfolio newsletters more than one shot at a top ranking.

Times: Are newsletter editors good at beating the market?

Hulbert: The first question to ask is whether newsletter writers can beat the market.

The answer is yes. But are they likely to? No.

Our experience suggests that 80% of newsletters over time won’t do as well as an unmanaged index [such as the Standard & Poor’s 500], and will do roughly the same as mutual funds and other professional money managers.

So if you’re picking an advisor, mutual fund or newsletter at random, four out of five times you’ll pick one that won’t fare as well as the market. The real question, then, is: Can you do better than random by picking an advisor intelligently? We think you can. That’s the help our service is dedicated to providing. When you pick an advisor intelligently, you can do better than those odds of 1 out of 5.

Times: So how do you pick a newsletter intelligently?

Hulbert: There are two crucial aspects. First, you should look at performance over a long period--five years as an absolute minimum. Hopefully, the period you examine will include a down market, a correction of at least 10%.

Second, look at the amount of risk that has been incurred. . . . Other things being equal, if two newsletters have made the same amount of money, you want to pick the one that has incurred the least risk. The one with less volatility stands a higher statistical probability of being able to replicate its performance.

Times: How do you evaluate risk?

Hulbert: In concept, if you have two newsletters, one of which has made twice as much money as the other while assuming twice as much risk, their performance on a risk-adjusted basis would be similar.

But you want to make twice as much money with less than twice as much risk to come out ahead on a risk-adjusted basis.

You don’t need to pay an advisor to double your return with twice the risk, because any of us can do that simply by going on margin.

Imagine you walked in on a poker game and were asked to bet which player would be the eventual winner. Would you automatically bet on the player with the biggest pile of chips on the table? No, because that player may have won one lucky round after taking wild risks and doing poorly in other rounds.

So if you could ask questions of the players, you’d find out who has been more consistent, because that player likely will be the eventual winner. When picking investment advisors, you’re also betting on who will be the eventual winner. Do you bet on the guy who has incurred a lot of risk? Not necessarily. In fact, that would be dangerous.

Times: Could you cite a newsletter example?

Hulbert: Yes. The Prudent Speculator [which pursues a value-oriented stock picking approach] has been the No. 1 newsletter of the past 15 years. . . . It has done that by being nearly 2-to-1 on leverage, on margin, during much of that time. As long as the market goes up, this newsletter will look like a genius. But when the market drops, it will incur a huge loss.

During the crash of ‘87, this portfolio lost something like 60% in one day. Very few subscribers are willing to incur that kind of risk, especially when we can’t assume the market over the next five years will behave like it has over the past five years.

Times: How do you determine buy and sell dates and prices for evaluating portfolios based on a newsletter’s advice?

Hulbert: We apply certain assumptions to all newsletters. A crucial one pertains to prices. In determining when a transaction is executed, we use the prices that prevail on the day that an anonymous subscriber receives his newsletter and would be able to act on the advice given.

This requires us to subscribe anonymously to a lot of newsletters in different ZIP Codes around the country. We don’t want newsletters sending us a copy before other subscribers receive it. So we spend something like $20,000 a year to subscribe to these various newsletters in different ZIP codes. After all, restaurant reviewers don’t announce to a restaurant when they’re going to write a review. We too want to be as anonymous as possible.

Times: How clear is newsletter advice?

Hulbert: Clarity or the lack thereof can be a problem. But it has been getting better. A lot of newsletters have created model portfolios, at least in part because they’re being tracked.

Times: Presumably, you recommend that people subscribe to a newsletter that they understand.

Hulbert: Absolutely. That raises some interesting points. For starters, once you pick a letter on the basis of performance, you also need to consider how much time it takes to follow it. If a newsletter requires daily attention but you don’t have that much attention to give, don’t even contemplate following it.

Times: Do you account for taxes and transaction costs?

Hulbert: Taxes, no. Transaction costs, yes. Stock transaction costs include both bid-asked spreads [trading markups] as well as brokerage commissions, and we take both into account. We get rate schedules from the largest discount brokerages, check the charges on representative trades that average investors might place, then factor those commissions into the transactions. Currently, commissions average 0.75%. So all stock transactions pay three-quarters of a percent on the buy side and the same when selling.

Times: Different newsletters focus on different investments--large stocks, small stocks, bonds or mutual funds, for example. Do you find that certain types of newsletters fare better than others?

Hulbert: No. In the right hands, almost any style or method will work. And in the wrong hands, almost any method won’t work.

Times: Can you name some favorite newsletters?

Hulbert: Readers need to draw their own subjective conclusions. I focus on the statistics. It’s not for me to like or dislike certain newsletters. I’m not an advisor. I don’t make recommendations.

Times: How about exaggerated advertising claims? It seems as if newsletters step over the bounds sometimes.

Hulbert: It happens a lot more than sometimes. That’s the reason we’re in this business, and I don’t think there has been a lot of improvement over the years.

When I started in 1980, I thought somewhat naively that outrageous advertising would be curbed under the watchful eye of a performance-monitoring service. In fact, it continues to go on. Indeed, a lot of advertisers take my name and twist the rankings around to make it look like they’re No. 1 when they aren’t. My general recommendation is to never trust anyone else’s claims on where they rank in the Hulbert Financial Digest. Not all newsletters lie about this, but many do.

Times: Any examples?

Hulbert: Years ago, Jay Schabacher’s Mutual Fund Investing claimed to be rated No. 1 by Hulbert, but the text below the headline explained that it was No. 1 among the 25 best-known newsletters in America. In reality, there were many other newsletters that had fared better. My feeling is that Schabacher’s newsletter simply eliminated any competitors that had done better.

Another newsletter, this one from William Donoghue, once advertised that among the newsletters it considered to be the real competition, it was highly rated.

Times: Don’t any government regulators keep an eye on newsletter claims?

Hulbert: Not directly, although there are some novel ways in which the SEC has gotten involved. In particular, mutual funds and other money managers are regulated in terms of advertising claims, and a number of newsletter editors do manage money.

For example, Stephen Leeb a few years ago claimed in an advertising piece that his signals could have turned $10,000 into something like $43 million over a 12-year period. I pointed out in a Forbes column that this was an after-the-fact reconstruction. About two years after that, the SEC charged that Leeb attracted people into his mutual fund under false pretense. Leeb ended up paying a fine and agreed not to do it again, but without admitting guilt.

Times: Anyone can start a newsletter. Do you think certain qualifications should be required?

Hulbert: Frankly, I don’t know what should be required. It would be great if PhDs had better records in the financial markets than high school graduates, but unfortunately there’s no such correlation.

Times: Do you think newsletter writers have a tendency to recommend more trades than might be warranted so that subscribers get their money’s worth in terms of action?

Hulbert: That incentive exists. . . . But I do know there are newsletters that resist it because their average holding periods are lengthy. For example, Market Logic [which covers stocks and options] has been holding recommended stocks for almost 10 years on average, and the Prudent Speculator has an average holding period of more than six years.

Times: Do you think people should buy one newsletter or diversify among several?

Hulbert: I won’t take a firm position on that, but I will say that if you subscribe to more than one newsletter, you should divide your portfolio into segments, following each newsletter’s model portfolio for part of the assets. Don’t try to find common denominators among the newsletters, because you usually won’t be able to. . . . You have to recognize that there is more than one road to riches.

Times: Do you recommend that people follow a newsletter’s advice blindly, and as quickly as possible?

Hulbert: That’s a tough question. I don’t think anyone should act blindly, but I also think that when people second-guess the advice, they usually regret it. What a good advisor can provide is discipline--discipline to resist the psychological temptation to be too conservative or greedy.

Borrowing from Greek mythology, people need to tie themselves to the mast like Ulysses did to resist the sirens’ song. I’ve come to the conclusion that, in the end, you pick a newsletter or other advisor to provide that discipline. So I’d say that once you feel comfortable with a newsletter, you should follow it quite literally and give it time to show its stuff, which likely will take several years.

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Profile

Mark Hulbert, editor, Hulbert Financial Digest, a monthly newsletter reviewing financial newsletters (introductory rate: $59 a year; regular rate, $135 a year; [888] HULBERT)

Background: Bachelor’s degree in philosophy and political science from Haverford College; master’s degree in philosophy, politics and economics from Oxford University. Started newsletter in 1980, shortly after leaving graduate school.

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Assessing the Assessors

The Hulbert Financial Digest monitors and rates the performance of about 500 investment newsletters. Performance ratings are made on the basis of a model portfolio, either as the newsletter presents it or created by the digest for tracking purposes. Here are the leading performers among the 62 newsletters the digest tracks that are at least 10 years old. Digest performance scores are risk-adjusted, based on the Wilshire 5,000 stock index. Newsletters with scores above 100 have delivered a greater return than the Wilshire 5,000 for each unit of risk; newsletters with scores below 100 have delivered lower returns than the Wilshire 5,000 per unit of risk.

Top 5 newsletters, performance only, for the 10-year period ended Nov. 30:

1. OTC Insight

10 year annualized return: +29.7%

Risk adjusted rating: 78.1

Recommends high-performance small-capitalization stocks; (800) 955-9566

2. Prudent Speculator

10 year annualized return: 27.7%

Risk adjusted rating: 79.1

Pursues a value-oriented stock picking approach, frequently augmented by the use of margin or leverage; (714) 497-7657

3. MPT Review

10 year annualized return: +26.6%

Risk adjusted rating: 84.2