EXCERPTS FROM BILL GRIFFETH’S BOOK ENTITLED
THE MUTUAL FUND MASTERS
Released December 5, 1994
Bill Griffeth: Much was made back in December of 1991 when you took over the brand new Growth & Income fund at Dreyfus. You know, people were saying here’s an economist suddenly taking over as a money manager. I guess they forget that you managed money in a previous life.
Richard Hoey: That’s true. I started out in the business working in an investment counsel firm which managed money for substantial individuals. It was basically a two-man investment counsel firm.
Griffeth: Were you very successful?
Hoey: Well, yes, it was a reasonably successful business. I don’t know whether I would say very successful. We had a pretty decent performance back then, although you didn’t have the emphasis on performance the way you do now.
Griffeth: What years were those?
Hoey: Actually, I started before sophomore and junior year when I was at Yale. I commuted down several times a week to New York.
Griffeth: So you were managing money in college.
Hoey: Yes. I was commuting down from Yale a couple of days a week. I had one of those majors that met from 2 to 5 p.m. on Wednesdays, and then you had to read 100 books. That type of thing.
Griffeth: Were you getting credits for managing the money?
Hoey: No, no, I was getting credits for reading the books. [laughing] I was getting money to finance my weekends…
Basically the man whose firm it was kind of taught me the business. He had been a portfolio manager at Calvin Bullock which was an old mutual fund firm. And I worked for him for about eight years managing balanced accounts of stocks, convertibles and bonds for individuals with accounts of several million dollars each.
…there are certain things you learn in terms of investment philosophy that are accumulated from the mistakes you make. In other words, I’ll make new and creative mistakes this year, but I’ll try not to make the same mistakes next year. So there’s a learning process when you are involved in running portfolios.
Now in the 1960s, we had a blow-off type of bull market in the 1966 through 1968 period.
Griffeth: The Go-Go years.
Hoey: Yes, it was just an explosive bull market, especially for secondary and lower quality stocks. And then we had a pretty tough bear market after that. So that was kind of my learning curve. I rate portfolio managers by how many bear markets they’ve lived through, and I’ve lived through the one that was linked to the credit crunch of 1966, the one that went down because of the credit crunch of 1970, the one that went down as the credit crunch of 1974, the one that went down as the credit crunch of 1980, and then the one in 1982 and then 1987, if you count that as a bear market, which I think you should.
Griffeth: So are you a money manager who became an economist or an economist who decided to manage money as well?
Hoey: Well, it was kind of both. I took my graduate work in economics while I was working as a portfolio manager. Then I went to NYU graduate School and took economics, got my MBA, and then I did course work for the doctorate. I didn’t do my dissertation, so I’m not Dr. Hoey, but I did the economics course work in graduate school. So, therefore, I was mixing the economics from the academic side with the practical experience of managing money right from the beginning.
Griffeth: When you worked at Pru-Bache, Becker, and Drexel you were the chief economist and many times you also served on the investment policy committee, didn’t you?
Hoey: Yes, in some portion, and I was also serving on the stock selection committee which is not that common for the chief economist.
…During several portions of that time I was the investment strategist as well as the chief economist of the firm. That was true when I was at W.E. Hutton, not E.F. but W.E. That was true when I was at Thomson McKinnon, it was true a portion of the time when I was at Bache. I think I’m the only fool who has ever been both the chief economist and investment strategist of a major firm simultaneously. That was at Bache.
Griffeth: Why?
Hoey: I found it interesting. At least we didn’t have too much disagreement about how the economic outlook fit the investment strategy.
Griffeth: And now you’re able to do that again with Dreyfus. How did that start?
Hoey: I came over here in July of 1991, and I joined as chief economist. Part of my objective was to end up running a mutual fund and see whether it would succeed. It wasn’t promised to me but it was a possibility, and so when the new fund opened up they offered to let me do it.
Griffeth: And I guess there were no qualms on your part?
Hoey: No, no. Having run money before I was interested in doing it, and also—being at Dreyfus—I had more time because I wasn’t a “sell side economist” trying to get on the I.I. list…
Griffeth: So they brought this fund to you to manage. Did the prospectus dictate the investment philosophy you had to use, or were you able to mold the fund with your own philosophy?
Hoey: The investment philosophy in the prospectus was broad enough that I was able to pretty much use my own to put the portfolio together.
Griffeth: And what is that philosophy?
Hoey: My philosophy is basically what’s known in pension fund circles as “top down, bottom up” which is to say you start with a top down view of the world economy, the U.S. economy, interest rates, market outlook, sector outlook and then mix that with the bottom up approach of finding individual stocks that fit your macro-view.
In addition, I believe in switching among sectors very aggressively in terms of being substantially underweighted in certain sectors and substantially overweighted in others. I don’t believe in what’s called in the business “closet indexing,” which is making very minor deviations from the index you’re competing against.
Griffeth: Do you manage the amount of risk in your portfolio based on your top down view of the markets?
Hoey: I try to manage the level of risk. …there are periods when I choose to raise the risk level by buying high-risk, high-potential securities, and then there are periods when I sell out the high-risk securities and move toward higher grade securities...
At the end of 1993, we also had a blow-off in the emerging market stocks, so I started to sell them in December and continued to sell them in early 1994. Now a lot of these emerging market stocks that I owned had generated good gains, and in some cases I gave back a portion of the gains, but I got a lot of this money back out before the full decline set in.
Griffeth: So you try to be a pretty nimble trader.
Hoey: Well, I didn’t start out intending to do that, but what I found was that the behavior of the speculative fervor in the market place was such that stock prices were much more volatile than their underlying fundamentals. I would tend to buy some areas with the intention of holding them for three years, and then if they ran to excessive levels I was forced by prudence to cut back.
Griffeth: …After you have identified an economic trend and the industry groups that will benefit from that trend, how do you choose the stocks within those groups for your portfolio?
Hoey: Let me answer that by pointing out that in terms of the macro top down view, I’m using a multi-scenario approach. I don’t come at it saying I can see one scenario or one outcome, and therefore I can pick just the portfolio that will work for that. I don’t, because I can’t see the future.
Instead, what I try to do is say there’s a most likely scenario, a next most likely scenario, and a third most likely scenario. And given the probabilities of these outcomes, what kind of portfolio can I build that will have the best risk reward within that context. In other words, I’m trying to rationally evaluate different possible outcomes that can occur in kind of a multiple scenario top down frame work.
Griffeth: Okay, then take us to the next stage.
Hoey: So then after I have developed a world outlook on the global economy, interest rates, and currencies and an outlook on the domestic economy, interest rates, the stock market, and various sectors, I say, “These are the industries that seem to make sense.” Then I look at the specific companies in those industries. I talk to our own analysts to see what ideas are coming up from them. I try to talk to company managements to see whether my conclusions from the top down point of view are in fact validated by the information that’s coming up from the individual companies. Sometimes it’s consistent and sometimes it’s inconsistent because of some specific characteristic of the company. Or sometimes it’s inconsistent because my top down conclusion is wrong. And so you need the information from the individual companies, a) to find out whether they fit the theme, or b) as a check and balance to tell you whether or not your theme is right to begin with. Often, the bottom up information will tell you that your top down theme is wrong. In other words, you’ve got a wonderful theory but they’re telling you it’s just not happening out there in the real world.
Griffeth: Then what do you do?
Hoey: Then you try to figure out what is going on. In other words, what is the cause of that. One of the things I’ve concluded is that in the process of forecasting for 20 years, the big mistakes are not mistakes about facts. The big mistakes are mistakes about the cause-and-effect linkages.
Griffeth: Do you have a for instance?
Hoey: You get a situation where you have a conclusion that the economy is fairly strong and you start to get information up from companies that their orders are fading away on you.
Griffeth: Do you then change your economic scenario?
Hoey: Yes, I go back to re-examine it and modify the scenario in terms of probabilities, taking into account the additional information I am receiving. And so what you’ve got is a daily process of changing the probabilities of different scenarios.
Let’s say you have developed a scenario that says there’s going to be a lot of inflation because oil prices are going to go up. Then you met with the oil companies, and they tell you that the supply and demand they are currently experiencing doesn’t support your scenario. Then you have to decide whether they just haven’t seen it yet and it’s in the macro background or whether you’re just wrong.
Griffeth: It’s a great argument for bringing some economists out of their proverbial ivory towers.
Hoey: Well, yes. I think there is a kind of generic economics taught that’s a little bit like teaching doctors medicine for the healthy patient. Instead, in order to really understand how the system really works, you have to see how it reacts when the normal processes don’t work that well. You have to examine what’s actually going on.
Now I use different schools of economics to monitor business cycle indications, but one of them is institutional economics which is used to understand how the financial system actually works as opposed to how it’s supposed to work in theory. I have a peculiar characteristic which is that I’ve been on the scene for most of the financial crises of the last 25 years. And so I understand the way the system works, especially when it’s under stress. Back in 1970 when I was managing money at John B. Braine Inc., we owned the bonds of the Penn Central Company. Penn Central went bankrupt when the commercial paper couldn’t be sold by Goldman Sachs. Well, that was a learning experience as to how the financial system works.
In 1974 I was a W.E. Hutton and I made a forecast that we’d have big trouble in the Eurodollar market and that some brokerage firms would go out of business. Unfortunately, about four months later it was my own brokerage firm that went out of business!
In 1980 I was chief economist of Bache when Bunker Hunt ended up with too much silver. He had borrowed twice the net worth of Bache to be in the silver market, and Bache nearly went bankrupt.
And then in 1990 I was chief economist of Drexel Burnham when the junk bond market collapsed, and they went bankrupt…
I accumulated through the process of being on the scene of these financial crises kind of an institutional economics understanding of the way the financial system, and the stock market, and the bond market, work under stress.
Griffeth: Let me ask you this, since you are an economist who manages money or a money manager who is also an economist. The stock market, it is said, forecasts the economy six to nine months down the road. I can think of an instance in 1982 when we were still in recession and the stock market started to rally. Those who didn’t understand the relationship between the stock market and the economy were scratching their heads. How could the stock market be rallying while we were still in recession? The question to you is, if you have a particular economic forecast in mind and the market seems to be discounting a different scenario, which way do you go? Does the money manager in you go with the market trend, or does the economist in you stick with your own forecast?
Hoey: First of all I think the consensus logic about the issue that you just raised is wrong.
Griffeth: In other words, you don’t believe the stock market is that much of a forecasting tool?
Hoey: Well, let’s put it this way: that characteristic is an accidental side effect of something else. What I believe is that the stock market and the economy are joint effects of the same cause. One operates with a short lag and the other with a long lag. And the cause is financial liquidity within the system. And so what you don’t want to do is make a forecast for the economy and then come back from that to your forecast for the stock market based on the hope that your forecast on the economy is right. What you want to do is look at the core driving force for both the stock market and for the economy, which is the financial liquidity in the system.