Andy Hagans sits down for an interview with Tom Forester to discuss capital preservation, hedging tactics, and more.
Fund Reference editor in chief Andy Hagans recently interviewed Tom Forester, manager of the Forester Value Fund (FVILX). Mr. Forester holds an MBA from the Kellogg School at Northwestern University, and also studied at the London Business School. The interview was completed over email, in June and July of this year.
Andy Hagans: Your investing style — and the fund you manage, the Forester Value Fund — puts a great emphasis on retention of capital. This investing philosophy requires patience, and a certain ability to go against the grain of market psychology. Were you born with this investing temperament? Or did it develop over time as a result of your investment experiences?
Tom Forester: I think one is born with a certain investing temperament and ability to go against the grain. That initial instinct is then molded and confirmed by experience, but has to be there from the beginning. Markets are a fascinating mix of logic and emotions. The logical tend to focus on fundamentals. The emotional follow momentum. We focus on fundamentals. This tends to make us correct over the long run, but can make us look funny when emotions greatly overshoot the fundamentals. One has to have the courage of one’s convictions when the market psychology goes crazy.
Andy Hagans: I’ll cite this impressive factoid straight from your fund’s Web page: “The Forester Value Fund was the ‘One Fund in 1,700 Made Money in ’08’ according to the Wall Street Journal, 1/5/09, (R2).” Very few managers performed well during this period, and some of the few who did, like John Paulson, became financial celebrities overnight. How did your out-performance during this rocky market period affect your notoriety?
Tom Forester: If you have to be known for something, we like that moniker. 2008 certainly raised our visibility. It allowed us to grow the fund in the following years and establish our strengths of capital preservation and solid returns. As the six-year bull market gets tired, investors tell us that they are looking to harvest profits and use more conservative funds like ours. We like our future prospects.
Andy Hagans: The Forester Value Fund uses hedging as a tactic to decrease risk. Can you talk a bit about your hedging strategy? What process do you use to determine when to hedge — and how much to hedge?
Tom Forester: We look at three factors to determine when and how much to hedge:
- Fundamentals/Macro: What is the ability of the economy to grow at a healthy rate sustainably?
- Valuations: Where are stocks trading compared to historical ranges? Are valuations reasonable given the current environment?
- Market Technicals: What is the trend and are there any signs it may reverse? What are market internals telling us about the underlying strength of the market?
Our assessment of these three areas determines the magnitude of the hedge. Our view of the fundamentals weighs most heavily on our decision, followed by valuations and then technicals. We use SPY (S&P 500 ETF) puts to hedge the portfolio due to their high liquidity.
Andy Hagans: The Shiller PE Ratio is roughly 27 right now; based on this metric, U.S. equities are richly priced. By the same long-term lens, bonds appear to be overvalued as well. Do you see any absolute value in any asset class right now? Because if it’s only possible to find relative value right now, that is, to say for instance U.S. stocks are less overpriced than U.S. bonds, then a hedged strategy makes a lot of sense.
Tom Forester: We believe that given lackluster economic growth and flat (or even declining) earnings, current valuations are pretty stretched. We also believe that current interest rates are artificially low and if they normalize/rise, that will put downward pressure on market multiples. The S&P 500s price-to-forward earnings multiple is currently 17.5, which is above the long-term average of 15.8 (and 14.4 excluding the dot-com bubble). As you pointed out, the Shiller PE ratio is 27, well above its long-term average of 16.6. As discussed above, valuation is one of the factors leading to our decision to hedge. While the U.S. equity asset class does not look undervalued, we have been able to find individual securities that are still attractively valued. Granted it is more difficult to find them now than it was a few years ago, but we have found about 30 individual names that we think offer good upside.
Andy Hagans: I can find plenty of risks in the market right now — rich valuations, the potential for rising interest rates, the potential for a new recession (coupled with deflation). What risks currently keep you up at night, as an equity fund manager?
Tom Forester: The world’s largest central banks have flooded the markets with liquidity. Excessive liquidity tends to lead to asset bubbles and extreme indebtedness, and we believe that this time is no different. Extremely low and even negative yields on government bonds indicate to us that these securities are overvalued (significantly overvalued in the case of negative yields). Many developed country sovereign debt levels are over 120 percent debt to GDP. This leads to slow growth and market fragility. When asset bubbles pop, other asset classes often suffer as well; the equity market in particular, which is sensitive to economic growth, stability and macroeconomic risk. We saw this in 2008 when the residential real estate bubble popped and led to a sharp decline in the equity market. If we weren’t hedged, this is the fear that would keep us up at night. However since the fund is well protected, we sleep pretty soundly.
September 11, 2015: This article has been updated with relevant links to the Fund Reference database of mutual funds.
About the Author: Andy Hagans
Andy Hagans is editor in chief for Fund Reference, and also serves as CEO of parent company Poseidon Financial. He is passionate about the “Bogleheads” school of investing, and is focused on helping investors achieve higher net returns via tax efficiency and fee minimization. He resides in southwest Michigan.