Quick Take:When it comes to picking stocks, cash flow is king for John Hussman, manager of Hussman Strategic Growth Fund (HSGFX). But he also recognizes that market volatility can get in the way of the best-laid plans. To meet this challenge, Hussman, a quantitative investor, will hedge to lessen the potential downside of securities primarily chosen for capital appreciation.
Hussman currently favors reasonably-priced, steadily growing stocks, which he’s offset by shorting the S&P 100 and the Russell 2000. He likes consumer discretionary and consumer staples companies, and believes his hedging strategy will bring the fund’s beta close to zero.
Hussman’s approach has paid off despite difficult market conditions. The fund rose 11.7% for the first half of the year, while the average small-cap blend fund fell 6.8%. Last year, the fund gained 14.7%, versus a loss of 3.2% for its peers.
While Hussman’s fund has done well during tough times, he said the separate accounts he has managed have outperformed most indexes over the last ten years. His fund, however, is too new to be ranked by Standard & Poor’s since it has less than three years of operating history.
The Full Interview:
S&P: What is your investment philosophy?
HUSSMAN: Our basic objective is long-term capital appreciation with an emphasis on capital preservation during unfavorable market conditions. To determine whether market conditions are unfavorable, we look at valuations and market action. We look at valuations in relation to the expected stream of free cash flow. We also look at such measures as price-to-book, and price-to-revenue, but we’re ultimately interested in the cash flows available for distribution to shareholders over time. With market action, we focus on the divergence of market subsectors from their prevailing trends, We believe that this conveys information. Instead of forecasting the future, we try to position ourselves to be in line with the prevailing market climate.
S&P: What’s your view of current valuations?
HUSSMAN: Stocks are not cheap by any means. Overall, valuation are near 18 times peak earnings, while the historic norm for price-to-peak earnings is about 14. On average, bear markets have ended at about 8.9 times peak earnings.
S&P: How have you structured the portfolio, given that you feel valuations are high?
HUSSMAN: Currently we are fully hedged. We have 100% invested in stocks with an offsetting short position in the S&P 100 and the Russell 2000. We’ve shorted the indexes to remove the effect of market fluctuations on our stock positions. We’re trying to bring our beta close to zero.
S&P: What’s behind the fund’s recent strong performance?