Hussman Funds

Dr. John Hussman is the principal and key shareholder of Hussman Econometrics Advisors which manages the Hussman Funds. The latter was initiated In July of 2000, when he left a cozy academic career in economics to launch the flagship Hussman Strategic Growth Fund. The stated objective of the flagship fund was to invest mainly in U.S. stocks and the necessary derivatives and options needed to create a hedged yet net long position, which in turn promised investors a cautious leaning towards downward protection while participating in the stock market.

Of course, this was a very timely message for many investors as they painfully watched their principal dwindling away as the NASDAQ bubble unwound and wreaked havoc in the other indices. The marketing of Dr. Hussman’s product with an orientation to principal protection (as far as possible when in the equity markets) was coincidental with the drawdown in 2000 and resounded with investor sentiment of the time.

Since then his Strategic Growth fund has averaged a net annual return of over 6% — although that might not seem like an overly impressive figure on first glance, one has to keep in mind that in the same period any of the main US indices had returned negative or, at the very best, flat returns.

Further, true to his adage of making principal protection a central theme, the Strategic Growth fund has only had one full negative year – that was a loss of 9% in 2008 when the S&P 500 had a loss of 37% as the finance system itself was at the brink of collapse.

Additionally, previous to that, he made his investors 14% in 2000, another 14% in 2001, and 21% in 2002, compared to a loss of 9%, 12%, and 22% by the S&P 500 in the respective years.

Following his almost immediate success in the flagship Strategic Growth fund, Dr. Hussman launched his Strategic Total Return Fund, which invests primarily in U.S. Treasury and government agency securities. Since its inception in September 2002, the fund has annualized a compounded return of over 7%, outperforming the Barclays US bond index by a total return of 17% in that time period.

Towards the start of 2010, Dr. Hussman launched the Strategic International Equity Fund to explore opportunities in equities outside the US. So far the fund has annualized a return of 2%, slightly outperforming the MSCI EAFE Index.

Among all the three funds, today Dr. Hussman, along with his fifty or so people staff, manages a total of over 6 billion dollars in assets. While using sophisticated models usually reserved for hedge funds that are only accessible to multi-millionaire individuals and institutional money, his funds have a minimum requirement of 1,000 dollars only and are structured as a no-load mutual fund so all the money goes to work right away and there is daily transparency and liquidity. Akin to many hedge fund managers, all of his liquid assets are invested in his own funds.

Investment Philosophy:

Even though Dr. Huffman considers many facets for investment selections, his primary emphasis is on two factors: valuation and market action. He relies upon his own well-elaborated definitions of valuation and market conditions. Using these two criterions, he processes available market information (micro and macro, individual stock and general stock market) to arrive at a “market climate” which determines the kind of security selection that will be best poised for positive returns.

For valuation purposes, he focuses on the future cash flow of the company rather than the company’s projected earnings or other metrics. The reason for this inclination to cash-flow is that he considers stocks to not be necessarily a claim on earnings since they need to be re-invested in capital that will eventually (in the intermediate time horizon) depreciate away.

Further, earnings are partly diluted by grants of options and partly by withholding them as required capital. Accordingly, stocks are more appropriately and foremost an entitlement on free cash flow rather than any other metric. This free cash flow may be applied to either pay dividends or to repurchase stock – in both instances contributing to the shareholder’s bottom-line. In this cash-flow model, then, the price that an investor pays for a specific stream of cash flow is inversely related to the long term return.

As to market action, in investment parlance, a favorable market action refers to the fact that trends are progressing positively across markets. Market action, as defined by Dr. Huffman, however, does not use that as the sole yardstick but also considers extremities of the duration and magnitude of the prevalent trends.

Hence, market action may be atypically graded against the prevailing trends and obvious stock index movements. Moreover, decline in the measure of market action usually implies that the investors have become risk averse or the market has become susceptible to failure. When security prices are highly valued, risk concerns are amplified which leads to lower prices. For this very reason, his funds place emphasis on protecting capital.

In essence, it is the quality of the market action that is analyzed rather than the quantity, i.e. duration and extent. Therefore market action is conveyed not by the obvious metrics but instead relies on how the various elements of market action diverge from the norm. The injection of “new information”, through change in data, diverges from previously anticipated result and, statistically speaking, current information is almost always in divergence with past information.

To site an example, if both Treasury bond and corporate bond yields are declining, it can be deduced that it is a question of interest rate. However, if one is falling and the other rising, this divergence contains valuable and actionable information.

Each distinctive combination of the factors of valuation and market action yields a specific market climate with its own profile of anticipatory risk and return. The intent is not in predicting the market direction but in juxtaposing the prevalent market climate to pertinent historical cases with favorable returns and thereby eschewing unfavorable ones.

Dr. Hussman does not chase short-term market predictions but seeks to “objectively identify the present”. He believes that some market conditions or climates can be identified as higher average return/risk tradeoffs than others. It is impossible to make forecasts using this average behavior as the basis. His intent is to identify through disciplined analysis the market climate that is prevalent at any specific time.

“Our discipline does not require us to predict the future. Rather we try to objectively identify the present.” Dr. Hussman, akin to Warren Buffett and Peter Lynch, emphasizes and abides by the role of discipline in investment management. His emphasis on the role of simple discipline in his complex strategy is rigorous and cogent.

Manager Background:

Before managing the Hussman Funds, Dr. Hussman was a professor of economics and international finance at the University of Michigan from 1992 to 1999. His academic research concentrated on market efficiency and information economics. Dr. Hussman holds a Ph.D. in economics from Stanford University (1992), and two degrees from Northwestern University: a Master’s in education and social policy (1985) and Bachelors in Economics (1983).

In the mid-eighties, Dr. Hussman also served as an options statistician for Peters & Company at the Chicago Board of Trade, and in 1988 began writing the Hussman Econometrics newsletter.

His son has autism and he contributes in understanding and combatting the condition through doing independent research in genetics and contributing funds to other similar efforts.

QUOTES

“You don’t tug on Superman’s cape. You don’t spit into the wind. Jim Croce had it right. Some things just have natural consequences. The same is true for buying stocks as long-term investments when they’re trading at 20 times peak earnings. Sooner or later, bad things are bound to happen.”

“It makes me cringe when one of these one-year winners goes on TV and talks about his small-cap China fund, because you just know what is coming.”

“It’s possible to have a great deal of experience, and yet to learn nothing. Early astronomers had this problem. They spent their lives watching the cosmos, and believed that as the Sun and the planets circled Earth, the planets would occasionally slow down, stop, and even move backwards for a while (“retrograde motion”) before continuing on their way around Earth. Investors have got this problem too. They keep looking at the stock market as if it revolves around them; that it exists to make their investments profitable, regardless of what price they pay. And they continue to learn the wrong lessons from their investing experiences.”

‘I’m very averse to attracting shareholders who don’t understand what I do—precisely because it will invite their frustration at points like this, when I’m very defensive for reasons that are unpopular on CNBC. My stance is very much at odds with the kind of arguments that are just hammered into investors by the popular media”

“When people talk about valuations, they tend to be talking about forward earnings. In other words, analyst estimates produced by Wall Street, and the problem with those forward earnings estimates is that they are very frequently so dead wrong as to be irresponsible.”

“The Buddha taught that you can only understand something by looking deeply at its interconnectedness to other things, and to our own selves – nothing has a separate existence. “This is, because that is; this is not, because that is not.” The problems and imbalances that have inflamed the world did not emerge from a vacuum. Rather, this is, because that is.”