Mark Hulbert has become the authority on investment newsletters. Hulbert began studying newsletter performance results nearly 30 years ago following his skeptical reaction to a presentation that promised investment success. Since 1980, he has published The Hulbert Financial Digest, which has tracked and analyzed the results of investment newsletters in a quantitative and analytic fashion. Although Hulbert sold the publication to MarketWatch.com (now owned by Dow Jones) in 2002, he continues to edit and manage it, as well as write columns for The New York Times and others.

Hulbert has been instrumental in the emergence of investment newsletters as a viable research option for professionals. Providing rigorous quantitative studies of performance has provided the evidence necessary for accurately evaluating newsletters. Hulbert's work has definitively established that some letters do outperform the broad market on a risk-adjusted basis. Mark believes that no one style or investment philosophy works best. “The common theme amongst newsletters that outperform is patience and discipline, sticking to one's approach even during those temporary times when it is out of sync with the market,” he says.

Registered Rep.: How did you first come to focus on investment newsletters as an area worthy of research and exploration?

Mark Hulbert: It was in 1979. I was attending an investment conference at which a lot of newsletter editors were speaking. And it was, of course, before the era of cell phones. Ten, 15 people would line up between talks at the pay phones. They were calling their brokers and they were obviously listening to every word that the editors would say in their speeches.

And I was very struck by the phenomena, because each of the speakers would be saying things that were contradictory to the previous speaker, and all of them were bragging about how much money would have been made had you only followed them over the past period. And you knew they couldn't all be telling the truth. I was quite shocked by this phenomenon; I had not been an investor up to that point. I had just gotten out of graduate school earlier that year, in 1979, and my degree was in philosophy. It sort of offended my philosophical sensibilities that people were able to get away with what seemed to me to be the financial equivalent of murder. They would be able to say whatever they wanted to say — and no one had the sort of institutional memory to go back and hold their feet to the fire.

And so the thought that led to the Hulbert Financial Digest was not the product of anything more substantial than that.

RR: For our readers picking the right newsletter may appear as difficult as picking an individual stock. Can you talk a little bit about what you regard as the most relevant criteria, and how you've arrived at the importance of those criteria?

MH: Obviously, I think performance is the most important criterion. I will say that there are lots of subtleties to saying “performance.” I think performance needs to be measured over very long periods of time. I am now convinced that five years is probably not long enough to separate out those who have genuine ability from those who do not have ability — even 10 years has very weak statistical ability to separate out those who do.

It's also important to look at performance on a risk-adjusted basis rather than just look at raw returns, again, in order not to give somebody with one lucky call undue credit.

Interestingly, I haven't found that there's any one particular investing approach that works best. I haven't found, for example, that buy and hold is always better than market timing, or that technical analysis is always better than fundamental analysis or vice versa. But there is one trait that the best newsletter writers have: Those who have the best long-term records have the discipline to stick with those systems during those temporary times in which their systems are out of sync with the market — and that's a crucial feature. [For a different opinion, turn to page 69.]

RR: It's interesting that you mentioned discipline, because discipline goes hand in hand with the idea of a systemic approach. If you were to think back to what you heard in the 1979, 1980 time frame, what were some of the hot investment themes then? How have they fared since?

MH: Most of the newsletters that were hot in 1979 were in the gold arena. This was right as gold was skyrocketing up to about $875 an ounce, which was its peak. And that was a peak that was not surpassed until a couple of years ago. It was the top of a bull market in gold that was followed by a bear market that lasted more than 20 years. It was breathtaking. And I think that was something that was very chastening and humbling to a lot of people — advisors and investors alike — since a bear market that long would be past the investment horizons of most investors.

And, of course, no one at the time who was bullish on gold for the long term was envisioning a 20-year bear market. So, one needs to have a strategy that is psychologically realistic as well as statistically impeccable. I find that the way I put it to my clients is that you can come up with a strategy that maybe on paper is statistically impeccable, but requires a degree of psychological discipline that is just psychologically untenable, that people just don't have what it takes.

Another way of putting it is that the strategy that may end up making the most money for an investor over time may not be the one that is statistically at the top of the list. And that's very ironic for somebody like me to be saying, because here I am looking at performance and the very dry objective statistics. But it is the case that my logic in analyzing these newsletters leads me to conclude that the newsletter that may be best for an investor is not necessarily the one at the absolute top of the rankings.

RR: It sounds like you're amplifying a theme from behavioral finance.

MH: That's right. What I think is wonderful about the focus that has come from behavioral finance work is the willingness and the eagerness to look at that aspect of the investment calculus. I'd say for way too many years the focus was on just the raw statistics. For example, the conclusion for years and years was that everyone should put their money in an index fund and hold for the long term, which I find statistically overwhelming. In fact, it's a boring argument.

The argument in favor of buy and hold is so statistically overwhelming, that we ought to spend our time debating something else. But that doesn't necessarily — and this I say ironically — mean it's the best thing for investors, because most investors do not buy and hold. Even when they claim they are, they end up throwing in the towel at the bottom of a bear market.

RR: Right, so it sounds like in addition to considering not only the performance track record of a newsletter, it's also wise to look at volatility and statistics on maximum drawdowns during the period of that achievement.

MH: A drawdown is one wonderful statistic. There are a lot of good statistics in that regard to look at. Basically they're all trying to capture this more psychological component of what is it like in real time to follow that newsletter's advice, and what's required to keep one's nose to the grindstone through those times in which they're out of sync with the market.

RR: Which risk measures do you use besides drawdown?

MH: Another one would be to look at lagging the overall market averages. I say this because if you look at value investing in the 1990s, value investing didn't actually lose money in 1996, 1997, 1998 or 1999 during those go-go years in which growth stocks were dominating the market. But they nevertheless lagged the broad market averages by huge amounts — for several years running, by double digit amounts. And a number of advisors tell me that actually their clients found that harder to tolerate than losing money. If they're losing money at a time when everyone else is losing money, that somehow was more tolerable than to be making only modest amounts of money when everyone else was seemingly making huge amounts of money.

RR: One of the difficulties with measuring performance is exactly that issue of exposures to hot sectors that you alluded to earlier. In a recent newsletter you pointed out that the Closed-End Fund Letter had not been published since 2004, and yet the unchanged static portfolio from that time has kept it ranked amongst the best-performing newsletters. There is a lesson there.

MH: It is very difficult to stay the course when others are perceived to be doing better. So that's one of the big lessons that comes through all the time. The other lesson that emerges is — and this is my philosophical background coming through — an analogy from Greek mythology: The Ulysses myth. He's sailing across the bay and the Sirens are singing, and he knows that if he listens to the Sirens it'll be certain death. He has his men tie him to the mast and promise not to untie him — even when he begs to be untied.

I like that myth, and it sort of accords with what I hear all the time from advisors: Basically, the whole financial world these days is a set of Sirens, and they're all appealing to us to do something to our portfolio. And what we need to do, I guess, the lesson that comes through, is that we need to figure out the financial equivalent of tying ourselves to the mast to avoid those Siren songs.