Blog - Investing Notes

March 28, 2006 - Classic Papers: The Value of Investment Newsletters?

Recent research on the (stock picking and market timing) abilities of experts to generate excess returns has focused mostly on mutual funds and hedge funds. This focus stems from data availability (mutual funds via SEC filings) and headline value (hedge funds). Where is the research on investment newsletters? How do they rate in terms of excess returns? Digging deeper than usual, we find two on-target papers: (1) the February 1995 paper entitled "Market Timing Ability and Volatility Implied in Investment Newsletters' Asset Allocation Recommendations" by John Graham and Campbell Harvey; and, (2) the November 1997 paper entitled "The Equity Performance of Investment Newsletters" by Andrew Metrick. Both papers draw upon the investment newsletter archive of the Hulbert Financial Digest. Using different aspects of this archive, they determine that:

In "Market Timing Ability and Volatility Implied in Investment Newsletters' Asset Allocation Recommendations", John Graham and Campbell Harvey use the equity/cash mix recommendations from a sample of 237 investment letters during 1980-1992 (15,172 total recommendations) to evaluate newsletter market timing ability. They conclude that:

• Fewer than 35% of the investment letters achieve long-term average returns that beat a matched S&P 500 index/cash buy-and-hold portfolio.
• Newsletters recommend increasing (decreasing) equity weights only 48.8% (51.4%) of the time before market advances (declines).
• Persistence of performance is much more evident among individual investment newsletters than among mutual funds, but this persistence is driven by poor performers. After one year of outperformance (underperformance), there is a 37.3% (67.6%) the newsletter portfolio will outperform (underperform) again the following year. There are 30 cases of outperformance for three consecutive years, compared to 168 cases of underperformance for three consecutive years.
• Disagreement among newsletters regarding future market direction is indicative of future market volatility.

In "The Equity Performance of Investment Newsletters", Andrew Metrick analyzes the stock recommendations of 145 investment newsletters during 1980-1995. He concludes that:

• In aggregate, the newsletters show no significant evidence of superior stock-picking ability.
• Some individual newsletters exhibit superior performance, but not more often than expected by chance.
• While there is some short-term performance persistence, a strategy of buying past winners does not earn statistically significant excess returns.

The following table, taken from this paper, compares the average (equal-weighted) newsletter performance with the value-weighted market (VWM) return for each year during 1980-1995. It shows that, on average, newsletters underperformed the market in 11 out of 16 years.

In summary, the aggregate market timing ability, positive performance persistence and stock picking ability of investment newsletters are unimpressive. Finding good gurus, able analysts, is no easier than identifying solid stocks.

These quantitative results are in general agreement with our more qualitative conclusions at Guru Grades on the aggregate ability of experts to predict the future direction of the stock market. Note especially the past performance summary of participants in MSN Money’s "Strategy Lab" since late 2001.

For related research, see Blog Synthesis: The Wisdom of Analysts, Experts and Gurus.