By Dr. Steve Sjuggerud

Saturday, June 9, 2007

How would you describe your particular style of investing?

My peculiarity is that I don't have a particular style of investing or, more exactly, I try to change my style to fit the conditions. If you look at the history of the Fund, it has changed its character many times. For the first ten years, it used practically no macro instruments. Afterwards, macro investing became the dominant theme. But more recently, we started investing in industrial assets. I would put it this way: I do not play according to a given set of rules; I look for changes in the rules of the game.

You have said that intuition is important in your investment success, so let's discuss intuition. What do you mean when you say you use intuition as an investment tool?

I work with hypotheses. I form a thesis about the anticipated sequence of events and then I compare the actual course of events with my thesis; that gives me a criterion by which I can evaluate my hypothesis.

This involves a certain element of intuition. But I'm sure the role of intuition is so great, because I also have a theoretical framework. In my investing, I tend to select situations that fit into framework. I look for conditions of disequilibrium. They send out certain signals that activate me. So my decisions are really made using a combination of theory and instinct. If you like, you may call it intuition.

Ordinarily, people think of money managers as having a combination of imagination and analytical ability. If you broke down all the skills into just those two categories, which one would be your particular strength – imagination or analytical ability?

I think my analytical abilities are rather deficient, but I do have a very strong critical faculty. I am not a professional security analyst. I would rather call myself an insecurity analyst.

That's a provocative statement. What do you mean by that?

I recognize that I may be wrong. This makes me insecure. My sense of insecurity keeps me alert, always ready to correct my errors. I do this on two levels. On the abstract level, I have turned the belief in my own fallibility into the cornerstone of an elaborate philosophy.

On a personal level, I am a very critical person who looks for defects in myself as well as in others. But, being so critical, I am also quite forgiving. I couldn't recognize my mistakes if I couldn't forgive myself. To others, being wrong is a source of shame; to me, recognizing my mistakes is a source of pride. Once we realize that imperfect understanding is the human condition, there is no shame in being wrong, only in failing to correct our mistakes.

You have said about yourself that you recognize your mistakes more quickly than others. That sounds like a necessary trait in investing. What do you look for to see if you are wrong?

As I told you before, I work with investment hypotheses. I watch whether the actual course of events corresponds to my expectations. If not, I realize that I am on the wrong track.

But sometimes things get off the track for a short time and then get back on the track. How do you know which is the case? That's what takes talent.

When there is a discrepancy between my expectations and the actual course of events, it doesn't mean that I dump my stock. I re-examine the thesis and try to establish what has gone wrong. I may adjust my thesis or I may find that there is some extraneous influence that has come into the picture. I may end up actually adding to my position rather than dumping it. But I certainly don't stay still and I don't ignore the discrepancy. I start a critical examination. And generally, I'm quite leery of changing my thesis to suit the changed circumstances, although I don't rule it out completely.

You have talked about the "joy of going against the herd." What signs do you look for to determine whether it is time to buck the trend?

Being so critical, I am often considered a contrarian. But I am very cautious about going against the herd; I am liable to be trampled on. According to my theory of initially self-reinforcing, but eventually self-defeating trends, the trend is your friend most of the way; trend followers only get hurt at inflection points, where the trend changes. Most of the time I am a trend follower, but all the time I am aware that I am a member of a herd and I am on the lookout for inflection points.

The prevailing wisdom is that markets are always right. I take the opposition position. I assume that markets are always wrong. Even if my assumption is occasionally wrong, I use it as a working hypothesis. It does not follow that one should always go against the prevailing trend. On the contrary, most of the time the trend prevails; only occasionally are the errors corrected. It is only on those occasions that one should go against the trend. This line of reasoning leads me to look for the flaw in every investment thesis.

My sense of insecurity is satisfied when I know what the flaw is. It doesn't make me discard the thesis. Rather, I can play it with greater confidence because I know what is wrong with it while the market does not. I am ahead of the curve. I watch out for telltale signs that a trend may be exhausted. Then I disengage from the herd and look for a different investment thesis. Or, if I think the trend has been carried to excess, I may probe going against it. Most of the time we are punished if we go against the trend. Only at an inflection point are we rewarded.

Market Notes

THE LARGEST BOND MARKET IN THE WORLD

The Japanese government-bond market is the largest government-bond market in the world.

Said another way, the Japanese government is the world's largest issuer of debt. For comparison, I went to the government websites and found the Japanese government has around $8.3 trillion in marketable debt outstanding, compared to only $4.4 trillion issued by the U.S. Treasury.

So when it comes to watching trends in global interest rates, I like to watch the Japanese bond market. Below is a long-term chart of the 10-year Japanese government bond yield. It's close to a seven-year low, and the long-term trend in interest rates looks to be changing from down to up.

If that's the case, you can expect interest rates all around the world to follow...

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