Morningstar Advisor - February/March 2010 - 44

Morningstar Conversation Hussman Strategic Growth HSGFX $14K 12 10 8 S&P 500 TR valuations. The two differed sharply on many topical subjects, such gold’s suitability as a long-term investment, the prospects for higher inflation, and the relevance of the concept of equity duration to assetallocation strategies, including target-date retirement funds. Equity duration is an academic idea that has been around since the early 1980s, but it has descended from the ivory tower in recent years and influenced investors, including Hussman. Duration, a measurement usually associated with bonds, measures interest-rate sensitivity and weighted average time to receipt of the bond’s cash flows. In bonds, the higher the yield to maturity, the shorter the duration will be. It turns out that you can also calculate the duration of the stock market. In general, as the market’s (dividend) yield rises, its duration decreases, and vice versa. Hussman uses this measurement, among other things, to argue that the glide paths of target-date funds should be dynamic even for an investor with no particular view about market conditions or future returns. Vanguard, like most other targetdate fund providers, uses static glide paths. The conversation has been edited for clarity and length. Ryan Leggio: Let’s start off talking about alternative asset classes. Gus, what types of alternatives do you believe are most appropriate for mainstream investors? Gus Sauter: Commodities, REITs, and Treasury Inflation-Protected Securities are alternative investment classes that make sense in many people’s portfolio allocations. right strategy for us. Other strategies we’re looking at are still in the research phase, but we like alternatives in general. RL: Do you include gold in commodities, or is it a separate asset class? GS: Gold is buried in that commodity bucket. Category Long Short Morningstar Rating QQQ Minimum Investment $1,000 Data as of Dec. 31, 2009. Expense Ratio (%) 1.09 5-Yr Anl Total Rtn (%) 1.65 5-Yr Anl TR % Rank Cat 56 Gold, honestly, is a foreign-currency play, particularly the way it’s performing today. Gold is not responding to a fear of inflation; it’s responding to a weak dollar and has rallied because of that. So, gold is certainly not something we would recommend as a long-term investment. We have stayed away from foreign-currency plays because, in the long run, we don’t expect there to be any return to foreign currencies. We think it’s a net-zero-sum game; the only way to benefit from it would be to try to time it. We just don’t have any confidence in our ability to time it. I should also point out that there’s a difference between investing in spot commodities and commodity futures. The rationale behind investing in commodity futures is supported by the theory of normalized backwardation, and that’s our thought process behind commodity futures as being a good diversifier with reasonable returns in a portfolio. If you go back 50 years, you’ll see that a broad basket of commodity futures has earned an appealing rate of return, somewhat in line with long-term equity returns with similar levels of risk. That is fully in keeping with the theory of normalized backwardation. One example is that from the early 1980s to the mid-1990s, energy prices were down something like 5% on an annualized basis, but an investment in energy futures returned about 7% per year. RL: John, what are your thoughts regarding alternative asset classes? John Hussman: For the typical investor, I don’t Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Vanguard Total Stock Market VTSMXMar-06Aug-06 Feb-07Jul-07 Mar-08Aug-08 Mar-09Aug-09Jan-10 Feb-05Jul-05 Feb-06Jul-06Dec-06 Jun-07 Feb-08Jul-08Dec-08 Jun-09 Dec-09 Mar-05 Sep-05 Apr-06Sep-06 Mar-07 Sep-07 Apr-08Sep-08 May-09 Nov-09 Apr-05 Oct-05 May-06 Nov-06 May-07 Nov-07 May-08 Nov-08 Jul-09 May-05 Nov-05 Jun-06 Jun-05 Aug-05 Oct-06 Apr-07 Oct-07 Jun-08 Aug-07 Oct-08 Sep-09 Oct-09 $14K 12 S&P 500 TR 10 8 Dec-05 Dec-07 Feb-09 Apr-09 Category 4 Large Blend Morningstar Rating QQQ Minimum Investment $3,000 Data as of Dec. 31, 2009. Expense Ratio (%) 0.16 5-Year Anl Total Rtn (%) 0.91 5-Yr Anl TR % Rank Cat 38 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 and Hussman together to talk shop would Feb-05Jul-05Dec-05 Jun-06 Feb-07Jul-07 Feb-08Jul-08Dec-08 Jun-09 Dec-09 Mar-05 Sep-05 May-06 Nov-06 May-07 Mar-08 Sep-08Feb-09Jul-09 Jan-10 Apr-05 Nov-05 Jul-06 Mar-07 Sep-07 May-08 Nov-08 May-09 Nov-09 May-05 Jun-05 Aug-05 Sep-06 Jun-07 Oct-06 Oct-07 Jun-08 Aug-08 Aug-09 resultOct-05 interestingAug-07 Apr-08 Oct-08Mar-09 Sep-09 in an Aug-06 Apr-07Morningstar Apr-09 Oct-09 Feb-06 Mar-06 Dec-06 Apr-06 Nov-07 Dec-07 Conversation. We were right. It was one of the liveliest interactions we’ve had. Their exchange on Nov. 3 ranged widely over alternative asset classes, global asset allocation, inflation, and current market At the same time, we’re looking at other types of alternatives as well, primarily on the beta side of the equation. We’ve looked at the hedge fund industry, and while we believe that hedge funds offer more beta than people realize, we still don’t think that it’s the believe that a standard commodity allocation, a standard TIPS allocation, or a standard 44 Morningstar Advisor February/March 2010

Morningstar Advisor - February/March 2010

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