INTRODUCTORY BOOKLET

Table of Contents
Dear Investor,

Mark Hulbert
2 2 3 3 4 4 6 8 9 10 11
Congratulations ! If used proper newsletter will ly, the Hulbert help you steer Financial Diges clear of bad in t monthly the advice that vestment advice will better your and direct you investment perf to ormance. Mine is no norm al investment ne invest. But I w wsletter. I will ill tell you who not tell you whe se advice is wor re to king. I am not affilia ted with any of completely obje the newsletters ctive in my anal I rate and theref yses of investm ore can be ent newsletter performance. Read through th is booklet expl Digest monthly aining how best newsletter and to use the Hulbe keep it handy as rt Financial a reference. Thank you for your subscriptio write or call. If n. If you have youre online, any questions, you can e-mail orders@marke please your questions twatch.com. or comments to Sincerely,

How To Use The HFD Whats Included In Your HFD Subscription Why You Should Ignore Short-Term Gains Other Ways of Accessing HFD Data How We Calculate Performance Frequently Asked Questions Risk & Risk-Adjusted Performance The HFDs Timing Scoreboard Newsletterss Most Popular Stocks The HFDs Sentiment Indices Methodology Used To Follow Ambiguous Advice

bert, Editor P.S. Each m onths HFD reports perfor of the previo mance throug us month. B h the last bu ecause we w are complete, siness day ont publish we cant pred until all our ict the exact issues. But ty calculations pically the m day on which onthly HFD you'll receiv first week of issues are pu e your the month. blished at th P.P.S. If you e end of the subscribe elec tronically, yo immediately u should rece after theyre ive your issu published. Pr once they ar es almost int subscrib e printed an ers will rece d mailed seco ive theirs nd class from Washington, D.C. HFD c/o Dow Jone s Online Cus tomer Service Princeton, NJ P.O. Box 30 08543-0300 0 (888) HULBE RT

Mark Hul

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How to Use The Hulbert Financial Digest

e presume that you subscribed to the Hulbert Financial Digest (HFD) at least in part in order to determine which investment newsletter(s) are worth following. The most important thing to keep in mind when picking a newsletter: There is no one perfect newsletter for all types of investors. Therefore, the best the HFD can do is articulate several principles that you should follow as you study the HFDs performance ratings.

Rule #3: Subscribe First on a Trial Basis

Before you actually begin investing according to a newsletters advice, you should follow the newsletter for a while on a trial basis. That way, you can determine whether or not you would be comfortable with the newsletters approach. For example, does the newsletter have a telephone hotline? Many have daily updates. Are you willing or able to call that hotline this often? Furthermore, how often does the newsletter recommend transactions?

Too Weight Rule #1: Dont Put Too Much Weight On Short erm Perfor formance Ter m Per formance
Performance over the recent past is an exceedingly unreliable guide to which adviser will perform well in the future (see article on page 3 of this booklet). When judging an adviser, always take into account as much of his performance history as is available. It is because of this rule that the performance scoreboards that appear on pages 7 and 8 of each HFD always focus on performance over periods of at least five years in length.

Rule #4: Have A Contingency Plan

This last rule is necessary because, unfortunately, there are no guarantees: Though you increase your odds of success by choosing a newsletter wisely, theres no assurance that it will perform as expected. Therefore, we suggest you formulate in advance what would lead you to stop following your chosen newsletter and subscribe to another one. Do not wait until after you have started following your chosen newsletter. This is because, at that point, your emotions kick in and you lose your objectivity. Every adviser, even the best ones, suffer through periods in which they are not in synch with the market. If you dont have a contingency plan, youre likely to bail out at just the wrong time. Be sure to adhere to whatever plan you formulate. For example, lets assume that you have decided to follow a newsletter because it has beaten the market on a risk-adjusted basis over the last 15 years. A good contingency plan might be to continue following it so long as its trailing 15-year risk-adjusted return is ahead of the market.

To Rule #2: Pay Attention To Risk

Once you are focusing on longer-term performance, you should interpret a newsletter editorss record in the context of how much risk he/she incurred (see pages 6 and 7). It is because of this rule that the HFDs monthly scoreboards rank newsletters two different waysboth on a raw-return basis and on a risk-adjusted basis. Other things being equal, we suggest you pay more attention to the riskadjusted rankings than to the non-risk-adjusted rankings.

Whats Included In Your HFD Subscription

s a subscriber to The Hulbert Financial Digest, you will receive 12 monthly issues. In ten months of the year (all those other than January and July), each issue will be eight pages in length. The January and July issues will be 24 pages long, consisting of 8 pages that conform to our regular monthly publishing template and 16 pages devoted to the latest update of our LongTerm Performance Ratings. Regular 8-Page Monthly Issues scoreboards: Performance scoreboards Each issue of the HFD provides rankings of the top five performing newsletters, on both a total return and a risk-adjusted basis, over the trailing periods over as long as the last 20 years. The scoreboard on page 8 focuses on all services in the HFDs database, while the scoreboard on page 7 of each issue focuses on just those that recommend mutual funds. profiles: Four full-page newsletter profiles On pages 3 through 6 of each monthly issue, the HFD profiles four of the newsletters that appear, or have recently appeared, in the page-7 or page-8 scoreboards. Thus, over the course of a 12-month subscription to the HFD, you will receive profiles of as many as 48 top-performing newsletters. The full-page profiles include graphs comparing the newsletters performances to the Dow Jones Wilshire 5000, detailed analysis of the newsletters riskiness and average holding period, and commentary by HFD editor Mark Hulbert. Hulbert: Analysis by Mark Hulbert The first two pages of each HFD are devoted to an in-depth analysis by Mark Hulbert of an investment topic that emerges from his more than two decades of tracking of investment newsletter performance. funds: Newsletters most popular stocks and mutual funds This listing appears in a box on page 7 of each monthly HFD. The listing shows which stocks and funds are most recommended by

the investment newsletters the HFD tracks, along with how many newsletters are recommending each stock and fund. The box also shows which stocks and funds are most liked by newsletters that have outperformed the market over the last decade, as well as those stocks that are least liked. For a detailed discussion of these listings, see page 9 in this Introductory Booklet. Indices: The HFDs Advisory Sentiment Indices These indices are reported each month in a box at the bottom of page 7. In this box youll see the average equity market exposure among all newsletters the HFD follows that offer stocks/cash allocation advice, as well as among those newsletters that have beaten the market over the last decade on a risk-adjusted basis. Similar indices appear for the gold and bond markets as well. For a detailed discussion of these indices, see page 10 in this Introductory Booklet. Long-Term Long-Term Performance Ratings Issues These 16-page supplements are included with the January and July issues, and cover performance through the previous December 31 and June 30, respectively. Every newsletter the HFD follows is included in these issues, along with each of their individual portfolios that are monitored. For each newsletter and portfolio, total return and risk-adjusted performances are listed over the previous year, and the last 5, 10, 15, and 20 years as well as over the entire period the HFD has monitored the newsletter. The Long Term Performance Ratings issues also report each portfolios risk, average holding period, and the HFDs clarity rating. The Long Term Performance Ratings issues also include timing-only ratings for those newsletters that offer market timing advice. For a full discussion of how these timing-only ratings are calculated, and what they mean, see page 8 of this Introductory Booklet.

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Short-Term Gains Are An Unreliable Guide

hort-term returns a very poor guide to future performance. It is far better to choose an investment newsletter on the basis of longer-term returns.

One-Year Returns Chasing One-Year Returns

Perfor formances Table 1. Per for mances of strategies that each January 1 invest in the top performing portfolios over the previous 1-, 5- or 10-year periods. (January 1, 1991, to August 31, 2005)

To illustrate, I constructed a hypothetical portfolio that exploited one-year returns. Each January 1, this portfolio invested in the best-performing newsletter portfolio from the 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 started following the Speculative Portfolio of a newsletter called Your Window Into The Future. This portfolio was chosen because 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 shifted gears so that it now was following the newsletter portfolio that did the best in 1992. This turned out to be the Options Portfolio of the Granville Market Letter, which outperformed all others the HFD followed in 1992 with a gain of 244.8%. In similar fashion, this hypothetical portfolio at the beginning of each subsequent year shifted into the previous calendar years top performer. Over the 14+ years from the beginning of 1991 through August 31, 2005, this portfolio produced an annualized loss of 24.0%! (See Table 1.)

produced a 5.5% annualized gain. Though this is still well below the return of the DJ Wilshire 5000 index, it nevertheless is far better than the 24.0% annualized loss of the portfolio that chased the best one-year performersand modestly better than the 3.9% annualized return produced by riskless T-Bills over this period.

10-Year Returns Chasing 10-Year Retur ns

What about a third hypothetical portfolio that invested in the ten-year best performers? It did even better. Over the same 14+ years, such a portfolio gained 9.4% annualized. These results are exactly what we should expect, if we believe that longer track records tell us more about an advisers abilities than shorter ones. And they clearly do. One-year returns do not help us tell the difference between an adviser whose return was the result of genuine ability and one who merely was lucky.

5-Year Returns Chasing 5-Year Returns

If one-year rankings do such a poor job, how about five-year rankings? To find out, I constructed another hypothetical portfolio that each January 1 invested in the portfolio with the best return over the previous five years. Over the entire 14+ years through August 31, 2005, our hypothetical portfolio that chased the five-year returns

Other ways of accessing HFD data

Hulbert Interactive

ulbert Interactive is the online research tool that gives you 24-hour access to the Hulbert Financial Digests performance ratings along with the ability to run customized queries on the nearly 200 stock and mutual fund newsletters with more than 500 recommended portfolios. To research a particular stock or mutual fund with Hulbert Interactive, you can simply enter the ticker symbol to instantly retrieve such information as a list of which investment newsletters currently are holding the security, the number of those services that have recently upgraded or downgraded that security, and which other stocks in the same industry that newsletters may also be recommending. Hulbert Interactive also enables you to construct a list of those stocks or funds that are most recommended. In constructing such a list, you can choose to use all newsletters the HFD follows, or a particular subgroup meeting any of a large number of filtering criteria that you specify. You can subscribe to Hulbert Interactive on a daily, monthly, or yearly basis. A subscription entitles you to unlimited use during the period for which you sign up. As a Hulbert Financial Digest subscriber (either print or online), you are entitled to sign up for a full year for just $99, a savings 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 signing up for a year s subscription, subscribers should go to marketwatch.com/commerce/HulbertInteractive.asp and use coupon code 8SYD30. Your discount will be automatically applied.

Individual Newsletter Profiles

ou can order a customized profile for any of the nearly 200 letters that the HFD follows. The cost is $25 per profile. For immediate processing of your profile order and e-mail delivery in PDF format, go to the Tools and Research tab at marketwatch.com. Alternately, you can order a profile over the phone by calling the HFD toll free at 1-888-HULBERT. The format of the profiles you can order from the HFD is similar to that used on pages 3 through 6 of every issue of the HFDwith one significant difference in the case of letters that recommend more than one portfolio. In such cases, the profiles that appear in the HFD focus on the average of the letters individual portfolios. In contrast, a customized profile for such a letter will include, in addition to this portfolio average, charts and graphs for each of this letters individual portfolios as well. Our intent in scheduling letters to be profiled in the HFD is to include, in any 12-month period, every letter that appears in one of the scoreboards on pages 7 or 8. To see an index that shows the issue date of the most recent HFD in which a letter was profiled, log onto the following page of the HFD website: http:// marketwatch.com/news/newsletters/nxd.asp.

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How We Calculate Performance

he HFD buys or sells a recommended security at its closing price on the day the HFD receives in the mail the letter making the recommendation. If the recommendation is made electronically (via phone hotline, email, FAX or website), it is executed at the average of the securitys high and low prices in the days session following receipt of the recommendation. If an editor wishes a trade to occur at other pricessuch as at the opening, or at limit pricesthen he/she must explicitly say so. Regardless of whether a market order is executed at the closing or the average price, however, the HFD adjusts that price upwards (when buying) or downwards (when selling) according to an estimate of that securitys bid-asked spread on that day. The HFD follows electronic recommendations only in the event those recommendations are made available to regular subscribers at no additional charge. The HFD follows telephone hotlines only in the event they are not updated more than once per day. The HFD debits a commission on all transactions, the rate of which is based on average commissions at the nations largest discount brokers on average-sized transactions. (This rate changes periodically to reflect current conditions.) For stocks, this rate was 1.0% each way through the end of 1996; 0.75% during 1997, 0.25% starting January 1, 1998; and 0.1% beginning January 1, 2006. For options, this rate was 3.0% each-way through the end of 1997, 2.0% beginning January 1, 1998; and 1.5% beginning January 1, 2006.

For futures contracts, the round-trip commission is (and has been) 0.05% of the contracts value. For mutual funds, loads and redemption fees are debited as appropriate. The HFDs calculations do not take taxes into account. However, dividends and fund distributions are credited on the day the security goes ex-dividend. When a newsletters advice is ambiguous the HFD constructs portfolios for it. The HFD applies the same methodology across the board for all such newsletters. For a detailed description of this methodology for ambiguous letters, turn to page 11. The HFD calculates timing-only performances as follows: Within each market, each timer earns the same rate of return when invested and the same rate of return when in cash. The proxy for investing in stocks is the Dow Jones Wilshire 5000s Value-Weighted Total Return Index; for gold, Londons P.M. Fixing Price; for bonds, the Shearson Lehman All-Maturities Treasury Index; and for cash, the 90-day T-Bill rate. The timing-only performances are designed to aid, in particular, the mutual fund switcher. Thus, in the event an editor recommends going short on a sell signal, we calculate two ratingsone assuming the investor does go short and the other assuming he goes into cash. In addition, these transactions are made at the closing price on the day subscribers are able to act on the advice. No commissions or taxes are debited. For a full discussion of our timing-only ratings, turn to page 8.

Frequently Asked Questions

Im happy with my present full-service broker; why should I look to a newsletter for investment advice?
If your broker is giving you enough profitable advice to justify paying full-service brokerage rates, then by all means stay with that broker. It may be, however, that if you were to analyze how much you pay for the advice (which is the difference between your brokers rates and a discount brokers), your enthusiasm might wane. But even if your enthusiasm remains undiminished, you still should take a look at newsletters because they may provide you with better advice for your money, or lead you in directions a broker is unlikely to take you. Because different subscribers are striving for different goals through their investing, there is no one single best adviser. An excellent options newsletter, for example, is of little use to someone for whom loss of capital is intolerable. Advisory letters specialize in various investment markets, and rarely will you find that the adviser who is best at calling turns in one area is also best in another.

What will the Hulbert Financial Digest do for me?

The HFD will help you formulate the most useful criteria with which to choose among investment strategies, and help you locate those services that best fulfill those criteria. Obviously, while proven performance is the single most important factor to consider when selecting an adviser, other considerations also must be taken into account. What is your risk threshold, for example? How much of a gambler are you? Do you roll the dice and participate in the office pool, or are you risk averse, unable to sleep nights when an investment moves against you? Is your worst nightmare receiving a

Which is the best investment newsletter?

This crucial question is not nearly as simple as 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 best for what I want to achieve?

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margin call, or are you willing to risk a lot in hopes of catching a really big winner? No amount of performance data can decide for you what amount of risk you are willing to incur. That is something you must decide for yourselftaking into account your age, financial status, family situation, sense of security and so forth. Only after answering these questions can you pick an adviser intelligently; a top-performing letter may be inappropriate for you if it exceeds your risk threshold. Another consideration is the clarity of the advice given. Some newsletter writers (as well as many other purveyors of financial advice, for that matter) are notorious for their ambiguous statements, talking out of both sides of their mouths at once. Some advisers, for example, will discuss in each issue both the bullish and bearish cases for the stock market, and in the next issue quote only that portion that makes them look clairvoyant. Others do not provide consistent follow-up advice on the stocks mentioned in earlier issues, instead mentioning just those that have performed the best in the interim. The HFD specifically rates the clarity and completeness of the advice contained in each newsletter. This is listed under clarity in the Long Term Performance Ratings table.

achieve adequate portfolio diversification while keeping commissions at low. Through purchases of mutual or personal funds, however, you can inexpensively achieve that diversification for as little as the minimum purchase amount (typically just a few thousand dollars).

I recently received lots of advertising about a particular newsletter that I dont see covered in the HFD. Is there something wrong with that newsletter that keeps you from following it?
There are many different reasons that could account for a newsletters absence from the HFD Performance Ratings, so you can conclude nothing from that absence. Many popular newsletters, for example, do not provide model portfolios or sufficiently clear advice for the HFD to construct portfolios for them. So while they may be excellent at what they do provide (be it market commentary, philosophical discussions, or educational articles), the HFD cannot come up with a Performance Rating for them. But a letters absence from the HFDs rankings may simply be due to the fact that we have not received many requests to follow it. The HFD chooses among the many newsletters it could add according to the wishes of subscribers. The HFD tries to satisfy subscribers first. If you have a particular newsletter you would like to see added, we invite you to let us know.

I once compared the HFD ratings with mutual fund performance and found that there were more high-performing funds than newsletters. Why shouldnt I just invest in mutual funds?
You still would have to decide which mutual funds to invest in, when to invest in them, and when 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. Funds are often parts of families of funds, and a fairer comparison with newsletters would be with the average of all the mutual funds within a family. With so many funds in these mutual fund families, it would be surprising if one or another of each family of funds was not at the top a given quarters or years rankings. But that doesnt mean that those fund families possess any particularly special investment genius. Indeed, the particular genius of those fund families is a marketing rather than an investment genius: Since one of their funds always will be at or near the top, their marketing efforts can be little more than fill-in-the-blank affairs. Just as mutual fund families should be compared on the basis of some average, so should those newsletters that recommend more than one model portfolio. Newsletters are ranked by portfolio average in the scoreboards that appear on pages 7 and 8 of each monthly HFD. Having said this, however, many newsletter subscribers would do well to consider mutual funds (either the open-end funds you see listed every day in the newspaper or the personal mutual funds you can construct on the web). Without substantial amounts to invest in individual stocks, it is very difficult on ones own to

How should I use the HFDs performance data? Should I switch between newsletters the way some investors switch between mutual funds?
If new evidence develops that suggests your current letter is not for you, then by all means you should switch to another. Similarly, if your financial situation changes, then switching also may be in order. But as a general rule you should not switch back and forth between newsletters as cavalierly or as frequently as many mutual fund switchers do between their chosen mutual funds. Once you have chosen a good newsletterafter checking out its long-term track record, examining its risk level and assuring yourself that it is in accord with your ownthen you probably should stick with it and give it a chance. This isnt to say that the newsletter you have chosen will be the perfect one for you (as if any service can fit that description). But the problem with constantly second-guessing your chosen letter (or with secondguessing any adviser, for that matter) is that you most likely will be tempted to second-guess at the worst possible times. Your emotions can be your worst enemy when investing, and the goal of a newsletter or strategy should be to impose a discipline that helps you resist your temptations to second-guess. As articulated in rule #4 on page 2 of this booklet, therefore, you should formulate a contingency plan in advance for when you will switch from your chosen letter to an alternative.

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Risk-Adjusted Performance

isk and risk-adjusted performance are two different things. Risk is defined by the HFD as volatility. A newsletter therefore will be defined as having low risk if its performance is consistent, and having high risk if its performance exhibits dramatic swings. In contrast, risk-adjusted performance reports the relationship between performance and risk. It answers the question: how well does a newsletter exploit risk? What does this mean? Take a look at the accompanying graph. Notice that both hypothetical newsletters produced precisely the same rate of return during 1994. The only difference between them is the path they followed to achieve that return. Newsletter A pursued an incredibly wild path, while Newsletter B traversed a fairly steady and consistent path. On an intuitive level, most investors understand that Newsletter B is a better bet for future performance than Newsletter A. Why? Because they can see from the graph that Newsletter As performance for the year was much more likely to have been the result of luck alone. Ask yourself: Which

newsletters performance is more pre- this fraction. And since that is a much dictable? If you were a gambler, which larger number in the case of Newsletwould you bet on? Since Newsletter Bs ter A (about 27 times larger, in fact), performance is so much more steady the resulting value of this fraction for and consistent, most investors can im- Newsletter A will be correspondingly mediately see why it should receive that much lower. their bet. Be careful not to confuse risk and All that the HFDs risk adjustment risk-adjusted performance. When does is provide a numeric measure- it comes to risk, you should want less ment of what our intuition already tells of it. But when it comes to risk-adjusted us. It is based on whats known as the performance, you should want more. Sharpe Ratio (named after William Sharpe, Volatility The High Price of High Volatility the Nobel-prize win- Both Newsletter A and B made the same amount of money ning former Stanford in 1994. Yet Newsletter B did so with much less volatility University finance pro- and risk, and hence will have a much higher risk-adjusted performance. fessor): In the numerator of this ratio is performance, and in the 90% denominator is risk or 80% volatility: Newsletter A 70% Performance 60% Newsletter B Volatility/Risk 50% Since both Newsletter 40% As and Bs perfor30% mances are identical, 20% the only difference in 10% their risk-adjusted per0% formances can be 12/93 2/94 4/94 6/94 8/94 10/94 12/94 traced to what appears in the denominator of

The Importance of Adjusting For Risk

hether you go for an aggressive investment style or a cautious one is a matter of personal preference. Some people like to take risks in the hope of even bigger rewards. Others prefer to limit their risks and will settle for smaller rewards. But whether you are a lion or a lamb when it comes to investments, you want an investment adviser that justifies whatever level of risk he/she incurs. Most investors fail to appreciate this crucial role played by risk. They tend to pick the adviser with the hottest recent performance. This is kind of like walking into a poker game and betting on the player who happens to have the biggest pile of chips in front of him. You dont know whether he won the heap in a wild gamble or whether he piled it up gradually by playing both good hands

and bad hands well. For example, consider the Prudent Speculator Portfolio from a newsletter called the Prudent Speculator, edited currently by John Buckingham, though at the time by Al Frank. Investors were eager to sign up in the summer of 1987, since at the time this newsletter was the top performer among letters the HFD had followed since mid-1980: Its model portfolio had beaten the Dow Jones Wilshire 5000 over the previous seven years, 686.4% to 274.1%. Yet the Prudent Speculator Portfolio was a poor bet for future gains, this 686.4% gain notwithstanding. To get that performance, it had been incurring too much risk. Why was this portfolio a poor bet? Over those 7 years, it was 2 1/2 times more volatile, or risky, than the mar-

ket itself. To justify being that risky, the Prudent Speculator Portfolio would have had to make even more than 686.4%. On a risk-adjusted basis, therefore, it was not ahead of the market. In the 1987 Crash, the Prudent Speculator Portfolio lost nearly 60%. Pointing out today that this portfolio was a poor bet in 1987 is not just 20:20 hindsight on our part, either. After reporting in the July 1987 HFD that the Prudent Speculator Portfolio had not beaten the stock market on a risk-adjusted basis, I wrote: Now is the time to be extremely choosy in insisting that your particular newsletter makes the most of the risk it incurs. Those newsletters that do poorly on a risk-adjusted basis when the market is going up are likely to be particularly disappointing when the market goes down.

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HFDs Risk-Adjusted Numbers

The HFD adjusts newsletters performances for risk to give subscribers advance warning of situations like the Prudent Speculators. Our risk-adjusted ratings appear in several locations, including the right-hand side of the scoreboards on pages 7 and 8 in each monthly issue. Consider the Prudent Speculator again, for example. According to the HFD, its Prudent Speculator Portfolio gained 5,981% from mid-1980 through August 31, 2005 (16.3% annualized), far outpacing the 1,982% gain of the Dow Jones Wilshire 5000 Index (12.8% annualized). On a risk-adjusted basis, however, this portfolio slightly lags the DJ Wilshire 5000, having produced an average gain of 0.141% per month per unit of risk, in contrast to 0.142% for the DJ Wilshire 5000. But what does this 0.141% or 0.142% really mean? The precise formula appears in the article at the top of page 6. In what follows, we present a user-friendly way of understanding these risk-adjusted ratings. Imagine comparing each letter to an index fund portfolio whose risk level has been increased (through the use of leverage) or decreased (by mixing it with cash) to match the newsletters. Only if the newsletter does better than this adjusted index fund has it beaten the market on a risk-adjusted basis.

Graph I to Graph I. The Prudent Speculator Portfolio vs. the right preLeveraged Index Portfolio* sents this comIf you were willing to incur as much risk as the Prudent Specparison in the ulator Portfolio, you could have made more with an index fund. case of the Prudent Speculator Portfolio. On a raw, unadjusted basis from mid1980 through August 31, 2005, this portfolio gained a cumulative total of 5,981% (16.3% annualized). (This portfolios performance is represented by the heavier line in the graph). *The Dow Jones Wilshire 5000 leveraged upward to match the volatility of The Prudent Speculator Portfolio. Over this 25+ year period, furthermore, this letters portfolio was nearly 2.4 times other ways of understanding this apriskier than the stock market itself. proach to risk adjustment. Another is The fainter line on the graph shows just the flip side of the first: Instead of how an index fund would have per- leveraging an index fund upwards in formed had it been bought on enough order to match the Prudent Speculator margin that its risk was the same as Portfolios volatility, we can leverage the Prudent Speculator Portfolio. As the Prudent Speculator Portfolio you can see, this adjusted index fund downwards so that its volatility portfolio beat the Prudent Speculator matches the stock market itself. To do Portfolio, gaining over 6,332% (17.9% so, we have to construct a portfolio that annualized). Thus, on a risk-adjusted has just the right allocation to the Prubasis, the Prudent Speculator Portfo- dent Speculator Portfolio (keeping the lio didnt beat rest in T-Bills) so that the resultant mixture has the same volatility (or the market. This is why risk) as the market. Graph II. DJ Wilshire 5000 vs. De-Leveraged adjusting perThis approach is illustrated in Prudent Speculator Portfolio* formance for Graph II. As before, the Prudent When the effect of the newsletters high risk is removed, risk is so im- Speculator Portfolios performance is it under-performs the market. portant. If we represented by the bolder line, while were not to do the stock market by the fainter line. so, we would Once again, after adjusting for risk, conclude that the stock market came out ahead. the Prudent Both the first and second apS p e c u l a t o r proaches reach the same conclusions. Portfolio added Our advice: focus on whichever apvalue, since it proach enables you best to make sense beat the mar- of risk adjustment. ket over this We now have an answer to what period by a the HFD means when it reports that wide margin. the Prudent Speculator Portfolios riskYet that lead adjusted performance over the last 25+ over the mar- years to have been 0.141% per month ket was due to per unit of risk, vs. 0.142% for the DJ the asusmption Wilshire 5000. This is simply a numeri* The Prudent Speculator Portfolio leveraged downward to of a lot of risk. cal representation of what you see plotmatch the volatility of the market. There are ted in Graphs I and II.

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The HFDs Timing Scoreboard

o illustrate whats included in, and what questions can be answered by, the HFDs Timing Scoreboard, consider the following parable. Imagine that you are looking for a good market-timing newsletter, and are choosing between two advisers named Midas Timer and Midas Picker. Assume further that the model portfolios of both have been equally profitable. On performance grounds alone, thus, there would appear to be no basis for deciding which of the two of them would be a better bet as a market timer. In fact, however, Midas Timer would be a much better bet for timing the market: He has a Midas Touch when it comes to picking the markets tops and bottoms. Unfortunately, however, Mr. Timers Midas Touch does not extend to picking individual stocks or mutual funds. Those individual picks are so dismal, in fact, that he loses the benefit his great timing otherwise would provide him. Hence, his model portfolios performance has been mediocre. Contrast the experience of Mr. Timer with Midas Picker, who is a mirror image of Mr. Timer: Mr. Picker has a Midas Touch when it comes to picking individual stock and mutual funds but has no ability to time the market. In fact, his stock selection abilities have been good enough to overcome the effects of his bad timing; but just as with Mr. Timer, his bad timing counteracts his great stock and fund selections to cause his portfolios performance to be merely mediocre. None of this would be obvious, however, from an investigation of their respective Performance Ratings. Both would appear to be equally good bets, since they made exactly the same amount of money. Some additional measurements are needed to pinpoint which has been the better market timer.

funds, the hypothetical portfolios constructed for purposes of the Timing Scoreboard buy or sell a comparable dollar amount of the Dow Jones Wilshire 5000 Total-Return Index (which is the index the HFD uses as a proxy for the stock market as a whole). Lets return to the parable of the two Midas advisers to illustrate. When Midas Timer recommends that subscribers become 100% invested in a particular basket of stocks and mutual funds, the Timing Scoreboard becomes 100% invested in hypothetical shares of the DJ Wilshire 5000. So when the market subsequently goes up (as it inevitably does when Midas Timer recommends buying), this hypothetical portfolio goes up too even though Mr. Timers specific model portfolio is languishing due to his dismal stock and mutual fund picks. Likewise, a hypothetical portfolio is constructed to measure the timing of Midas Picker, going into and out of shares of the DJ Wilshire 5000 index as he recommends buying and selling individual stocks and mutual funds. Thus, even though those individual picks help to rescue the performance of Mr. Pickers specific model portfolio, they have no effect on the performance of the hypothetical portfolio constructed for the HFDs Timing Scoreboard. This latter portfolio shows up Mr. Pickers poor timing for what it is. After all is said and done, how will these two advisers perform on a Timing-Only basis? Midas Timer will be ranked at the top and Midas Picker will be ranked at the bottom. And you will be able to go straight to the adviser who has a great record at timing the market, and avoid the one who doesnt.

model portfolio as well as of its hypothetical timing-only portfolio. The question to ask yourself: which of these newsletters has been better over these 25+ years at picking securities that would beat the stock market? The answer: Growth Stock Outlook. Why? Because GSOs model portfolio outperformed its corresponding timing-only portfolio. That means that GSOs recommended stocks outperformed the DJ Wilshire during the times they were owned. In contrast, the securities owned by the Nearer Term Trading Portfolio of The Dines Letters lagged the market. How do we know that? Because we can see from its corresponding timing-only portfolio that if its securities had done as well as the DJ Wilshire 5000, then the portfolio would have performed better (10.2% annualized, instead of 0.3%).

The Timing Scoreboard and Mutual Fund Investors

The parable of the two Midass illustrates most of what you need to know about HFDs Timing Scoreboard. A few details remain to be discussed, however. The most important additional detail you need to keep in mind is that the Timing Scoreboard is designed first and foremost to help the mutual fund investor. On the assumption that most of those interested in these calculations use noload or very-low-load funds, the calculations did not charge commissions. If you are using a market timer to trade stocks or other securities for which commissions can be a significant factor, therefore, you should adjust these figures accordingly. Another consequence of designing the Timing Scoreboard for the mutual fund investor concerns short selling. Up until very recently, there has been no possibility of such an investor actually going short the market. Instead, fund switchers have had to go into cash upon receiving a sell signal from whatever adviser or timing system they were using. This confronted the Timing Scoreboard with a new

Stockpickers and TimingOnly Ratings

The Timing Scoreboard

It is precisely for these reasons that the HFD created a Timing Scoreboard. Imagine how well you might do if you looked to Midas Timer for just timing advice, ignoring his dismal stock and mutual fund selections. The HFDs Timing Scoreboard allows you to focus on Midas Timers great timing. It extracts the pure timing component from Midas Timers advice, and measures just that. The Timing Scoreboard does this by constructing hypothetical portfolios for each adviser that are identical to those advisers model portfolios except for one crucial difference. Every time they recommend that their model portfolios purchase or sell individual stocks or

By the same token, the Timing Scoreboard helps us to identify those advisers who are like the Midas Picker in the above parable. All we have to do is compare the performance of a letters model portfolio with its timing-only rating. If its model did better, then you can conclude that its recommended stock and continued at bottom of page 9 fund selections outperformed the market. Timing-Only Gains Through 8/31/2005 Take a look at the chart at right, which reports the performances of two newsletters through 8/31/ 05. For each newsletter, youll find the performances both of its

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Newsletters Most Popular Stocks

he one question that subscribers ask perhaps more than any other concerns the performance of newsletters most popular stocks. Our response often is to first ask them another question: What do they think? Is popularity a virtue or a vice? HFD subscribers are almost evenly divided on this question. On the one hand, some argue that a stock must be a particularly good bet if it impresses so many newsletter editors. On the other hand, others are convinced that these stocks ought to be avoidedon the theory that they must be highly priced and overvalued by the time lots of newsletter subscribers have bought them. Clearly, intuition isnt going to help us discover whether newsletters most popular stocks ought to be sought or shunned. Fortunately, several years ago the HFD researched the matter.

The HFDs Study

The HFD exhaustively studied newsletters most popular stocks over 16 years. Our study took from each months issue of the HFD the group of stocks that were recommended by the most newsletters. If there were fewer than five in this category, then we took stocks from the next most highly-recommended category. Thus, for each month between November 1980 (which is when the HFD first began providing this information) and April 2006, we came up with at least five stocks that were recommended more often than any others. All told, this involved 2,119 stocks. We chose to define popularity in this way because the criteria for being most popular has changed over the years. Because we were following only about a fourth as many newsletters in 1980, it was rare for a stock to be recommended by more than two or three letters. Today, in contrast, its not unusual for ten or more letters we track to recommend the same stock at the same time. The HFD measured the perfor-

mance of these 2,119 stocks over two peri- exposure. In both cases, the HFDs list of ods. The first was the subsequent month, letters most popular stocks would be a since that is how often the HFD is pub- good place to start in your decision-maklished and how often subscribers would ing process. be able to find out whether a stock continIn any case, we need to keep in ues to be among the most popular. The mind that, over time, around 80% of all second measurement period was the sub- advisers portfolios underperform the sequent 12 months. Both the monthly and market. Merely to equal the markets rethe yearly returns were then compared to turn thus places a strategy at the 80th that of the Dow Jones Wilshire 5000s percentile. The HFDs study thus suggests Value-Weighted Total Return index. that newsletters most popular stocks perThe results? Over the subsequent form better than the average newsletter. month following their elevation to mostConclusion popular status, these stocks outperformed At a minimum, therefore, the the stock market by a margin of 10 basis HFDs study confirms there is no reason points. Over the subsequent year, they to avoid a stock simply because it enjoys outperformed the DJ Wilshire by 62 ba- immense popularity among newsletters. sis points. (See chart below.) In some circumstances, furthermore, such How significant are these re- popularity might actually be a reason to sults? On the one hand, these margins are take a second look at a particular stock. not large enough to make up for transacLet me end with a disclosure note: tion costs. Assuming 0.5% one-way trans- the HFD is not an investment adviser. action costs, for example, you wouldnt have Neither the appearance of a stock in the beaten the market by buying and selling list of newsletters most popular stocks, these stocks. On the other hand, there nor its subsequent removal, constitutes arent contrarian grounds for avoiding let- either a buy or a sell signal by the HFD. ters most-popular stocks. The Average Amount By Which Newsletters Nevertheless, there are other Outperfor formed Most Popular Stocks Outper formed the Dow situations in which Jones Wilshire 5000 (11/1980 to 4/2006) newsletters most popular stocks may 0.70% be more attractive. Lets say that you 0.60% have decided for 0.50% other reasons to invest in the stock 0.40% market, and thus are going to be in0.30% curring transaction 0.20% costs anyway. Or, alternately, you 0.10% may be looking to sell some of your 0.00% stocks in order to Over subsequent month Over subsequent year reduce your portfolios market why the Timing Scoreboard contains two ratings for some advisers timing systems: one that goes short on sell signals and the other that goes into cash on sell signals. The principle behind these additional sections of the Timing Scoreboard is the same as that underlying the stock market portion. The sole difference was the proxy used for the market. For stock market timing, as mentioned above, the HFD used the DJ Wilshire 5000. For the Gold Timing Scoreboard, the HFD uses the London P.M. Fixing Price, and for bonds the Shearson Lehman Treasury Index (a total return index, taking into account all U.S. Treasury securities with maturities greater than one year).

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wrinkle, since some of the advisers advocate actually going short the market upon receipt of a sell signal. To deal with this wrinkle, the HFD constructs two different Timing Scoreboard portfolios for those advisers who actually recommend going short. The first of the two goes short in shares of the DJ Wilshire 5000 upon receipt of a sell signal, while the second mimicking the typical mutual fund investorinstead goes into cash. This explains

Gold and Bond Timers

The above discussion of market timing has focused exclusively upon the stock market. But in recent years there has been a growing interest in timing the bond and gold markets as well. To respond to this interest, the HFD expanded its Timing Scoreboard to measure timing in these sectors as well.

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The HFDs Sentiment Indices

ne of the ancillary benefits the HFD derives from tracking hundreds of investment newsletter portfolios is the ability to derive a consensus judgment among those advisers about where the various financial markets are headed. Of course, never will every newsletter editor be bullish, nor a time when theyll all be bearish. But there will be times when the editors, on balance, are more bullish than at others. The HFD calculates the consensus of investment newsletter editors opinions by averaging the percentage market exposure among all of them who provide specific allocation advice. To illustrate, lets assume that the HFD follows just two newsletters, and that one recommends that its subscribers be 100% invested in stocks and the other recommends subscribers be just 50% invested in equities (keeping the other 50% in cash). In such an event, the HFD would report an average market exposure of 75%. Most investors who focus on advisory sentiment interpret the data in a contrarian fashion. That is, they do the opposite of the consensus, especially when that consensus approaches an extreme: They become more bullish as advisors on balance become excessively bearish, and vice versa. Because the HFD is not an investment advisor, we cannot advise you on any particular investment strategy for using the HFDs advisory sentiment data. However, we can report a number of characteristics of the historical data. And there is support in the data for the notion that advisers become more bullish as the market approaches peaks and become more bearish as the market declines.

Take a Advisers look at the graph in the upper right corner of this page. It plots advisers average equity exposure over the last 25+ years, as well as the Dow Jones Wilshire 5000. Notice, for example, how sentiment grew more bearish after the Crash of 1987, as well during some parts of the bear market that began in 2000. Similarly, notice how sentiment tends to become more bullish as the stock market rises. A warning, however: the inverse correlation between these two data series isnt perfect. So you cant interpret the HFDs stock newsletter sentiment index in any mechanical way. Notice, for example, that the peak of advisory bullishness over the last 25 years occurred in early 1985, whichas is illustrated in the accompanying graphwas not a bad time at all to be invested in equities. And yet knee-jerk contrarians who automatically do the opposite of the consensus would have been out of stocks altogether. By the way, the HFD also calculates similar advisory sentiment indices for the NASDAQ, gold and bond markets. The latter two of these sentiment indices are plotted in the charts at the bottom of this page. In general the same things can

Stock Market Exposure

be said about these data as for the stock sentiment data.

Ordering the HFD Sentiment Indices

The HFDs four different advisory sentiment indices appear in each issue of the HFD, updating their values as of the close of the previous month. Thus, for example, the July HFD updates these three indices as of the end of June. The HFD actually updates these indices daily, however. If you wish, you can purchase these data from the HFD, which will be e-mailed directly to you on either a daily or a weekly basis If youre interested in a subscription to any or all of these sentiment indices, call the HFD at the number listed on the front page of this booklet. Alternately, you can e-mail John Kimble at john.kimble@dowjones.com

Advisers Gold Market Exposure

Advisers Bond Market Exposure

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Methodology Used To Follow Ambiguous Advice B

y definition, when a newsletters advice is ambiguous, it is impossible to ascertain every last detail of the portfolios the advisers want their subscribers to construct. To deal with each case of ambiguity impartially (since the HFD has no stake in one or another letter doing well), the HFD set down in advance rules that would be followed automatically in the event a newsletter was silent or vague about this or that aspect of constructing a model portfolio. You should realize, however, that there is no one right way for a subscriber to deal with vague and ambiguous investment advice. One of the inevitable consequences of ambiguity is that different subscribers, each faithfully following such advice, nevertheless may invest their portfolios in quite different wayswith accordingly different results. To the extent you would have interpreted a newsletters advice differently than did the HFD, your results would vary from those the HFD publishes. Since there is no one correct way to deal with ambiguities, you shouldnt assume the HFDs resolution of them is the only way that could be chosen by fair and reasonable people. This is not to say that the methodology chosen by the HFD is unfair or unrevealing, however. On the contrary, it is eminently fair. Furthermoreand this is crucialthe HFD applies this methodology across the board.

advice, then all he or she need do is say clearly and unambiguouslywhat a subscriber is supposed to do. What are the rules the HFD follows when dealing with ambiguous advice? Basically, the HFD constructs portfolios for non-model-portfolio letters that have the following characteristics, unless the newsletter 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 given time. If an editor wants to have a certain percentage of subscribers portfolios out of the market and in cash, wants the model portfolio to be margined, or wants unequal allocation of the portfolio between its various components, and so on, then the HFD requires the editor to say so specifically.

with many transactions over a years time. When you total up your gains and losses at the end of the year, it is in terms of your actual portfolio: you have gained or lost in real dollars. It is only fair that newsletters be judged similarly.

Rebalancing
lso implicit in the rules listed above is that the hypothetical portfolios set up by the HFD to track non-model-portfolio newsletters enter into transactions that no one subscriber to a newsletter is likely to undertake. To understand the need for these additional transactions, consider a service which recommends purchasing a new stock without also selling a currentlyheld position. Where are you to get the money to buy the new stock? Undoubtedly, each subscriber will deal with this question differently, some selling out this or that security, some selling out partial positions in several securities, and some deploying new amounts of cash not previously invested according to the advice of this particular newsletter. Taking these various subscriber responses into account, what portfolio weight will the new recommendation have relative to other securities in the portfolio? The least arbitrary response to this question is to assume that the new recommendation will have the same weight in the portfolio as the other securities in that portfolio (unless the newsletter specifically advises to the contrary). Therefore, after buying the new recommendation, the HFD undertakes a number of rebalancing transactions so that thereafter all securities in the portfolio enjoy equal weight. This means that if a stock has gained enough in value to have greater-than-equal weight, a portion of it is sold to bring it back into line with the others. And if a stock has declined in value so that it has less-thanequal weight, more shares are purchased to bring it back to the same weight as others. (Commissions are not charged on rebalancing transactions).

Lies, Damn Lies, and Statistics

The HFDs Rules

ost of the HFDs rules come into play only in the event a newsletters advice in some way is silent or vague. If it clearly and unambiguously deals with all aspects of translating its advice into a portfolio, then the HFD follows that advice. Instead, the HFDs rules apply primarily to letters with some ambiguity in their advicethat is, letters rated B or C for clarity in the HFDs Long Term Performance Ratings. Not surprisingly, most of the letters that have been most upset with their HFD ratings over the years have to some degree been unclear or incomplete in their advice. Why is this not surprising? Because if it werent for that lack of clarity or completeness, there would be no doubt as to what those advisers would have their subscribers doand no doubt about how much money would have been made or lost. The next time an adviser questions the HFDs tracking of a letters advice, remember one thing above all else as you read what that adviser has to say: the ambiguities in their advice do not have to exist. If an editor disagrees with the HFDs interpretation of his

mplicit in this approach is that the HFD takes a total portfolio approach to rating newsletters. In other words, the HFD believes that the best way to measure a newsletters performance is by trying to decide how much to keep in cash, what weight to give to each position, and so on. To put it another way, it is not enough to say the average recommendation of newsletter ABC gained X%. Such a statement does not take into account the fact that a securitys weight in a portfolio is a crucial factor in newsletter performance. How a stock behaves when there are only 10 stocks in the portfolio should have a different impact than how it behaves when there are 100 stocks in a portfolio. This is a crucial point about how statistics can be misleading, which an example can help illustrate. Let us suppose that a $10,000 portfolio starts out the year divided equally between two investments, each of which lose 10% of their value (or $500 each) before being closed out. The portfolio now is worth $9,000. Suppose next that the portfolio becomes half invested in a stock that gains 10%. Ignoring interest earned on the portion kept in cash, the portfolio now is worth $9,450. If this portfolios adviser simply reported the average percentage gain or loss of his recommendations, he would tell you that he lost 3.33% (the average of two 10% losses and one 10% gain). But in fact the portfolio is worth just $9,450, which is 5.5% less than its $10,000 starting value. While the discrepancy between 3.3% and 5.5% may not seem huge, imagine the distortions created in a many-stock portfolio

New vs. Old Subscribers

ne way of thinking about the HFDs response to the above issue of rebalancing is to take the perspective of a new subscriber to the newsletter in question. Confronted with a list of recommended securities, the new subscriber intent on following the newsletters advice will divide his or her assets equally among them regardless of whether one of those recommendations is a newly-rated buy that was unaccompanied by a sell. The portfolio constructed by the HFD for this let-

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ter, after undertaking the various rebalancing transactions, will look just like the one constructed by the new subscriber. In general, other things being equal, the portfolios constructed by the HFD for nonmodel-portfolio letters will look like the ones constructed by new subscribers. The different perspectives of the new and old subscriber also come into focus in the HFDs treatment of buy and hold ratings. As pointed out above, the HFD constructs portfolios for non-model-portfolio letters out of those securities most highly rated by them. This means that if 50 stocks are on a recommended list, and of them 25 are rated buy and 25 are rated hold, the portfolio the HFD constructs will include just the 25 buys. And when a stock is downgraded from a buy to a hold, the HFDs hypothetical portfolio will sell that stock. (The only exceptions to this rule come if and when a newsletter specifically says that their stocks rated hold are just as highly recommended as their stocks rated buy, in which cases the HFDs portfolios include both the buys and the holds.) The HFDs orientation towards the new-subscriber perspective helps to explain this treatment of hold-rated securities. A new subscriber presumably will buy just those securities rated buy, while longer-term subscribers may or may not own the securities rated holddepending upon the length of time they have been subscribers and if they were following the newsletters advice at the time those securities were rated buy. How long should the HFD carry a hold-rated stock in a portfolio that is supposed to be representative of a wide variety of subscribers? Should we automatically sell it if it hasnt been mentioned as a buy within, say, the last three months? Or should we wait six months or a year? Rather than legislate an arbitrary cutoff for selling hold-rated securities that have been held for a certain period without an intervening buy recommendation, the HFD instead takes the perspective of the new subscriber and constructs the portfolios out of just the buyrated securities. To illustrate the pitfalls that would await the HFD if it were not to treat hold in this way, consider a letter that on January 1, 1980, recommended IBM as a buy. Assume further that it downgraded IBM to a hold on February 1, 1980, and has carried it as a hold in every issue up to the present. How many subscribers to that letter would have this stock in their portfolios today? If they faithfully followed the letters advice, only those who were subscribers during January 1980 would own it. For all other subscribers, the performance of IBM is irrelevant.

Replies to the Skeptics

ver the years the HFD has heard a number of objections to its treatment

of hold-rated securities, and you should be aware of the HFDs response. In that way you will know how to respond if and when particular newsletters use these objections as a way of dismissing their HFD performance ratings. One criticism of the HFDs treatment of holds is, simply, that hold means hold and not sell. But the point to bear in mind is that hold is ambiguous, and that there is no way of avoiding treating hold as something other than hold. To say that hold means hold misses the point, which is that holds meaning itself is not clear. Consider, for example, the consequences to new subscribers of deciding, in contrast to the HFD, that a hold should be treated as a buy. It would entail having them buy all of a letters recommendations, the holds as well as the buys. But if hold doesnt mean sell, then why should it mean buy? Is a hold a buy or a sell? It cant be both. The HFDs critics on this issue have resolved nothing with their suggested solution. Another objection to the HFDs treatment of holds is that it causes Performance Ratings for newsletters to be lower than otherwise. Howard Ruff of The Ruff Times articulates this objection as follows: If I recommended Squibb as a buy at 64, and made it a hold at 70 until it reached 90, Hulberts program would close me out at 70. But Ruffs criticism fails to focus on what the HFD does when, to use his example, Squibb is downgraded to a hold and is sold. The proceeds are not stuffed into a mattress, thus preventing Ruff from making more profits. Instead, the HFD reinvests the proceeds into stocks Ruff is rating more highly at that time. This is crucial to understand. The HFDs approach has the effect of keeping Ruffs portfolio invested in nothing other than the securities hes most highly rating. An example from Ruffs own use of buy and hold illustrates this important point. In November 1988, after several months of highly recommending several Australian investments, Ruffs enthusiasm lessened. Explaining that The Aussie dollar could slide if the greenback rallies and conceding that he wasnt convinced the U.S. dollar bull market is over, Ruff downgraded his recommendation on his Australian investments from buy to hold. Consider, thus, what happened to Ruffs portfolio when the HFD reoriented it out of these Australian investments into the other securities that Ruff liked better at that time. It was putting Ruffs best foot forward. The only way that the HFDs treatment of his portfolio could cause his performance to be worse would be for his Australian investments to perform better while rated hold than the securities he rated buy. But if that is the case, Ruff shouldnt have downgraded them to a hold in the first place. The finger of blame should not be pointed at the HFD in such a case. It

was he, not the HFD, that believed that these Australian investments had less potential and therefore should be downgraded to a hold. What is true for Ruff is true for all the non-model-portfolio newsletters. In general, the HFDs approach to buy and hold would reduce a newsletters performance only in the event its recommendations performed better while rated hold than while rated buy. But why should that be the case? It is not the HFD, but the newsletters themselves, that have chosen to downgrade stocks to hold. It is their editors who have decided that other stocks, rated buy, are better bets than those downgraded to hold. The HFD is taking them at their word.

Further Replies to Skeptics

nother criticism the HFD has received over the years concerns the issue of rebalancing. (As discussed above, for nonmodel-portfolio letters these rebalancing transactions entail selling off small portions of a portfolios better performers and buying more of a portfolios poorer performers.) Most commonly, editors have articulated their objection to this practice by arguing that it violates the cardinal rule to let your profits run. Of course, there is another investment clich that runs: Buy low, sell highand which is directly contradictory to these editors cardinal rule. But the point is not which clich is best; rather the point is that rebalancing is necessitated by ambiguous advice. If editors want to let their subscribers profits run, all they have to do is say so. Consider the case of a letter that, just prior to the 1987 crash, was recommending that 5% be invested in out-of-themoney puts. Because of the Crash, of course, those puts skyrocketed; by mid-November, in fact, when this letters next issue appeared, they represented nearly 50% of the portfolios value. What was a subscriber to do upon reading in that new issue, continue to have 5% of your portfolio invested in put options? Should he sell off the bulk of those put options to bring their percentage weight back down to 5%? Or does the adviser want the subscriber to continue to hold what was originally 5% but is now 50%? A case could be made for either course of action. Ambiguity has struck again. Some letter editors, recognizing this ambiguity, have clarified their advice. Theyll tell their subscribers, for example, that their puts which originally represented 1% of their portfolio now represent 5% of the portfolio, or whatever. If that is too heavy an investment in those puts, these advisers then would sell off a portion of them. Similar options for clarifying their advice are open to any adviser, of course. All they must do is say in their newsletters what they meanand not keep the HFD (or their other subscribers) guessing.

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