THEMUTUALFUNDMASTERS EXCERPTSFROMBILLGRIFFETHSBOOKENTITLED ReleasedDecember5,1994
BillGriffeth:MuchwasmadebackinDecemberof1991whenyoutookoverthebrand new Growth & Income fund at Dreyfus. You know, people were saying heres an economist suddenly taking overas amoney manager. Iguess theyforgetthatyou managedmoneyinapreviouslife.
RichardHoey: Thats true. Istartedout inthebusiness working inaninvestment counselfirmwhichmanagedmoneyforsubstantialindividuals.Itwasbasicallyatwo maninvestmentcounselfirm.
Griffeth:Wereyouverysuccessful?
Hoey:Well,yes,itwasareasonablysuccessfulbusiness.IdontknowwhetherIwould sayvery successful. Wehad apretty decent performance back then, although you didnthavetheemphasisonperformancethewayyoudonow.
Griffeth:Whatyearswerethose?
Hoey: Actually, Istartedbefore sophomore and junior year when I was atYale. I commuteddownseveraltimesaweektoNewYork.
Griffeth:Soyouweremanagingmoneyincollege.
Hoey:Yes.IwascommutingdownfromYaleacoupleofdaysaweek.Ihadoneof thosemajorsthatmetfrom2to5p.m.onWednesdays,andthenyouhadtoread100 books.Thattypeofthing.
Griffeth:Wereyougettingcreditsformanagingthemoney?
Hoey: No,no,Iwasgettingcredits forreadingthebooks. [laughing]Iwas getting moneytofinancemyweekends
Basicallythemanwhosefirmitwaskindoftaughtmethebusiness. Hehadbeena portfoliomanageratCalvinBullockwhichwasanoldmutualfundfirm.AndIworkedfor him for about eight years managing balanced accounts of stocks, convertibles and bondsforindividualswithaccountsofseveralmilliondollarseach.
there are certain things you learn in terms of investment philosophy that are accumulatedfromthemistakesyoumake. Inotherwords,Illmakenewandcreative mistakesthisyear,butIlltrynottomakethesamemistakesnextyear. Sotheresa learningprocesswhenyouareinvolvedinrunningportfolios.
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Now in the 1960s, we had a blowoff type of bull market in the 1966 through 1968 period.
Griffeth:TheGoGoyears.
Hoey: Yes,itwasjustanexplosivebullmarket,especiallyforsecondaryandlower qualitystocks.Andthenwehadaprettytoughbearmarketafterthat.Sothatwaskind ofmylearningcurve.Irateportfoliomanagersbyhowmanybearmarketstheyvelived through,andIvelivedthroughtheonethatwaslinkedtothecreditcrunchof1966,the onethatwentdownbecauseofthecreditcrunchof1970,theonethatwentdownasthe creditcrunchof1974,theonethatwentdownasthecreditcrunchof1980,andthenthe onein1982andthen1987,ifyoucountthatasabearmarket,whichIthinkyoushould.
Griffeth: Soareyouamoneymanagerwhobecameaneconomistoraneconomist whodecidedtomanagemoneyaswell?
Hoey: Well,itwaskindofboth. ItookmygraduateworkineconomicswhileIwas working as a portfolio manager. Then I went to NYU graduate School and took economics,gotmyMBA,andthenIdidcourseworkforthedoctorate. Ididntdomy dissertation, so Im not Dr. Hoey, but I did the economics course work in graduate school. So,therefore,Iwasmixingtheeconomics fromtheacademic sidewiththe practicalexperienceofmanagingmoneyrightfromthebeginning.
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Griffeth: When you worked at PruBache, Becker, and Drexel you were the chief economistandmanytimesyoualsoservedontheinvestmentpolicycommittee,didnt you?
Hoey: Yes,insomeportion,andIwasalsoservingonthestockselectioncommittee whichisnotthatcommonforthechiefeconomist.
DuringseveralportionsofthattimeIwastheinvestmentstrategistaswellasthechief economistofthefirm.ThatwastruewhenIwasatW.E.Hutton,notE.F.butW.E.That wastruewhenIwasatThomsonMcKinnon,itwastrueaportionofthetimewhenIwas atBache. IthinkImtheonlyfoolwhohaseverbeenboththechiefeconomistand investmentstrategistofamajorfirmsimultaneously.ThatwasatBache.
Griffeth:Why?
Hoey:Ifounditinteresting.Atleastwedidnthavetoomuchdisagreementabouthow theeconomicoutlookfittheinvestmentstrategy.
Griffeth:AndnowyoureabletodothatagainwithDreyfus.Howdidthatstart?
Hoey: IcameoverhereinJulyof1991,andIjoinedaschiefeconomist. Partofmy objectivewastoenduprunningamutualfundandseewhetheritwouldsucceed. It wasntpromisedtomebutitwasapossibility,andsowhenthenewfundopenedup theyofferedtoletmedoit.
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Griffeth:AndIguesstherewerenoqualmsonyourpart?
Hoey:No,no.HavingrunmoneybeforeIwasinterestedindoingit,andalsobeingat DreyfusIhadmoretimebecauseIwasntasellsideeconomisttryingtogetonthe I.I.list
Griffeth: Sotheybroughtthisfundtoyoutomanage.Didtheprospectusdictatethe investmentphilosophyyouhadtouse,orwereyouabletomoldthefundwithyourown philosophy?
Hoey:TheinvestmentphilosophyintheprospectuswasbroadenoughthatIwasable toprettymuchusemyowntoputtheportfoliotogether.
Griffeth:Andwhatisthatphilosophy?
Hoey: Myphilosophyisbasicallywhatsknowninpensionfundcirclesastopdown, bottomupwhichistosayyoustartwithatopdownviewoftheworldeconomy,theU.S. economy, interest rates, market outlook, sector outlook and then mix that with the bottomupapproachoffindingindividualstocksthatfityourmacroview.
Inaddition, Ibelieveinswitchingamongsectorsveryaggressively intermsofbeing substantiallyunderweightedincertainsectorsandsubstantiallyoverweightedinothers.
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Idontbelieveinwhatscalledinthebusinessclosetindexing,whichismakingvery minordeviationsfromtheindexyourecompetingagainst.
Griffeth: Doyoumanagetheamountofriskinyourportfoliobasedonyourtopdown viewofthemarkets?
Hoey:Itrytomanagethelevelofrisk.thereareperiodswhenIchoosetoraisethe risklevelbybuyinghighrisk,highpotentialsecurities,andthenthereareperiodswhenI selloutthehighrisksecuritiesandmovetowardhighergradesecurities...
Attheendof1993,wealsohadablowoffintheemergingmarketstocks,soIstartedto selltheminDecemberandcontinuedtoselltheminearly1994. Nowalotofthese emergingmarketstocksthatIownedhadgeneratedgoodgains,andinsomecasesI gavebackaportionofthegains,butIgotalotofthismoneybackoutbeforethefull declinesetin.
Griffeth:Soyoutrytobeaprettynimbletrader.
Hoey:Well,Ididntstartoutintendingtodothat,butwhatIfoundwasthatthebehavior ofthespeculativefervorinthemarketplacewassuchthatstockpricesweremuchmore volatilethantheirunderlyingfundamentals. Iwouldtendtobuysomeareaswiththe intentionofholdingthemforthreeyears,andtheniftheyrantoexcessivelevelsIwas forcedbyprudencetocutback.
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Griffeth:Afteryouhaveidentifiedaneconomictrendandtheindustrygroupsthatwill benefit from that trend, how do you choose the stocks within those groups for your portfolio?
Hoey:Letmeanswerthatbypointingoutthatintermsofthemacrotopdownview,Im usingamultiscenarioapproach.IdontcomeatitsayingIcanseeonescenarioorone outcome, and therefore I can pick just the portfolio that will work for that. I dont, becauseIcantseethefuture.
Instead,whatItrytodoissaytheresamostlikelyscenario,anextmostlikelyscenario, andathirdmostlikelyscenario. Andgiventheprobabilitiesoftheseoutcomes,what kindofportfoliocanIbuildthatwillhavethebestriskrewardwithinthatcontext. In otherwords,Imtryingtorationallyevaluatedifferentpossibleoutcomesthatcanoccur inkindofamultiplescenariotopdownframework.
Griffeth:Okay,thentakeustothenextstage.
Hoey:SothenafterIhavedevelopedaworldoutlookontheglobaleconomy,interest rates,andcurrenciesandanoutlookonthedomesticeconomy,interestrates,thestock market,andvarioussectors,Isay,Thesearetheindustriesthatseemtomakesense. ThenIlookatthespecificcompaniesinthoseindustries.Italktoourownanalyststo seewhatideasarecomingupfromthem.Itrytotalktocompanymanagementstosee whethermyconclusionsfromthetopdownpointofviewareinfactvalidatedbythe informationthatscomingupfromtheindividualcompanies.Sometimesitsconsistent
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andsometimesitsinconsistentbecauseofsomespecificcharacteristicofthecompany. Orsometimesitsinconsistentbecausemytopdownconclusioniswrong.Andsoyou needtheinformationfromtheindividualcompanies,a)tofindoutwhethertheyfitthe theme,orb)asacheckandbalancetotellyouwhetherornotyourthemeisrightto beginwith. Often,thebottomupinformationwilltellyouthatyourtopdownthemeis wrong.Inotherwords,youvegotawonderfultheorybuttheyretellingyouitsjustnot happeningoutthereintherealworld.
Griffeth:Thenwhatdoyoudo?
Hoey:Thenyoutrytofigureoutwhatisgoingon.Inotherwords,whatisthecauseof that.OneofthethingsIveconcludedisthatintheprocessofforecastingfor20years, thebigmistakesarenotmistakesaboutfacts.Thebigmistakesaremistakesaboutthe causeandeffectlinkages.
Griffeth:Doyouhaveaforinstance?
Hoey: You get a situation where you have a conclusion that the economy is fairly strongandyoustarttogetinformationupfromcompaniesthattheirordersarefading awayonyou.
Griffeth:Doyouthenchangeyoureconomicscenario?
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Hoey:Yes,Igobacktoreexamineitandmodifythescenariointermsofprobabilities, adailyprocessofchangingtheprobabilitiesofdifferentscenarios.
Letssayyouhavedevelopedascenariothatsaystheresgoingtobealotofinflation takingintoaccounttheadditionalinformationIamreceiving.Andsowhatyouvegotis becauseoilpricesaregoingtogoup.Thenyoumetwiththeoilcompanies,andthey tellyouthatthesupplyanddemandtheyarecurrentlyexperiencingdoesntsupportyour scenario.Thenyouhavetodecidewhethertheyjusthaventseenityetanditsinthe macrobackgroundorwhetheryourejustwrong.
Griffeth:Itsagreatargumentforbringingsomeeconomistsoutoftheirproverbialivory towers.
Hoey:Well,yes.Ithinkthereisakindofgenericeconomicstaughtthatsalittlebitlike teachingdoctorsmedicineforthehealthypatient.Instead,inordertoreallyunderstand howthesystemreallyworks,youhavetoseehowitreactswhenthenormalprocesses dontworkthatwell.Youhavetoexaminewhatsactuallygoingon.
NowIusedifferentschoolsofeconomicstomonitorbusinesscycleindications,butone ofthemisinstitutionaleconomicswhichisusedtounderstandhowthefinancialsystem actuallyworksasopposedtohowitssupposedtoworkintheory. Ihaveapeculiar characteristicwhichisthatIvebeenonthesceneformostofthefinancialcrisesofthe last25years.AndsoIunderstandthewaythesystemworks,especiallywhenitsunder stress.Backin1970whenIwasmanagingmoneyatJohnB.BraineInc.,weownedthe
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bondsofthePennCentralCompany.PennCentralwentbankruptwhenthecommercial papercouldntbesoldbyGoldmanSachs.Well,thatwasalearningexperienceasto howthefinancialsystemworks.
In1974IwasaW.E.HuttonandImadeaforecastthatwedhavebigtroubleinthe Eurodollar market and that some brokerage firms would go out of business. Unfortunately,aboutfourmonthslateritwasmyownbrokeragefirmthatwentoutof business!
In1980IwaschiefeconomistofBachewhenBunkerHuntendedupwithtoomuch silver. HehadborrowedtwicethenetworthofBachetobeinthesilvermarket,and Bachenearlywentbankrupt.
Andthenin1990IwaschiefeconomistofDrexelBurnhamwhenthejunkbondmarket collapsed,andtheywentbankrupt
Iaccumulatedthroughtheprocessofbeingonthesceneofthesefinancialcriseskindof aninstitutionaleconomicsunderstandingofthewaythefinancialsystem,andthestock market,andthebondmarket,workunderstress.
Griffeth: Letmeaskyouthis,sinceyouareaneconomistwhomanagesmoneyora moneymanagerwhoisalsoaneconomist.Thestockmarket,itissaid,forecaststhe economysixtoninemonthsdowntheroad.Icanthinkofaninstancein1982whenwe were still in recession and the stock market started to rally. Those who didnt
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understandtherelationshipbetweenthestockmarketandtheeconomywerescratching theirheads. Howcouldthestockmarketberallyingwhilewewerestillinrecession? The question to you is, if you have a particular economic forecast in mind and the marketseemstobediscountingadifferentscenario,whichwaydoyougo?Doesthe moneymanagerinyougowiththemarkettrend,ordoestheeconomistinyoustickwith yourownforecast?
Hoey: FirstofallIthinktheconsensuslogicabouttheissuethatyoujustraisedis wrong.
Griffeth: In other words, you dont believe the stock market is that much of a forecastingtool?
Hoey: Well, lets put it this way: that characteristic is an accidental side effect of something else. What Ibelieve is that thestock market andthe economy arejoint effectsofthesamecause.Oneoperateswithashortlagandtheotherwithalonglag. Andthecauseisfinancialliquiditywithinthesystem.Andsowhatyoudontwanttodo ismakeaforecastfortheeconomyandthencomebackfromthattoyourforecastfor thestockmarketbasedonthehopethatyourforecastontheeconomyisright.What youwanttodoislookatthecoredrivingforceforboththestockmarketandforthe economy,whichisthefinancialliquidityinthesystem.
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Griffeth: LetsgobacktomyexampleandputitinEnglish.Whatwashappeningin 1982whentheeconomywasstillmiredinrecessionandthestockmarketwastaking off?
Hoey: Well,itisverytraditionallateinrecessionsforthestockmarkettorise. Bear marketsendinmidtolaterecessionandbullmarketsstart. Sowhatwehadwasan absolutelyclassictypepatternwhereyourlowinthestockmarketinthesummerof 1982precededthelowintheeconomyafewmonthslater. Samethinghappenedin 1974and1975. YouhadadoublebottominthestockmarketinOctober1974and againinDecember1974,andyoureallydidntcomeoutoftherecessionuntilthespring of1975.
Theinterestinginstance,Ithink,is1990,becausein1990youwentintorecessioninan environment where few people forecast that you would go into a recession or bear market.Thereasonwasthattheyhadamodelintheirheadthathighinflationcausesa risingFedFundsratewhichcausesarecession. SosincetheFeddidnthaveabig inflation that caused it to raise the Fed Funds rate a lot, the conclusion that most forecastershadwaswewouldnthavearecession.
Ihadaforecastthatwewouldgointorecession. Why? Becausewehadfinancial illiquidity of a different sort. The correct model was that financial illiquidity causes recessions, and financial illiquidity causes bear markets. We had financial illiquidity linkedtothemeltdownofthesavingsandloans,themeltdownofthejunkbondmarket, ...