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Friday, March 28, 2008

There Are No Geniuses Department

I have noted many times that the past records of fund managers, or a top rating from Morningstar or any other financial publication is of little use in picking mutual funds. There is little persistence of returns and even impressive track records for funds seldom give a full picture of the risk adjusted return.

A recent case in point, highlighted in the March 21 WSJ is Bill Miller and his Legg Mason Value Trust (LMVTX). For years this fund had been the darling of the financial press as the manager stacked up 15 consecutive years of beating the S+P 500.

But we were really not surprised to read this in the WSJ:

Bear Is Bill Miller's Latest Setback

Legg Mason Star
'Was Surprised'
By Stock's Plunge

March 21, 2008; Page C1

At an investment conference last Friday, legendary stock picker Bill Miller of Legg Mason Inc. was caught off guard by a simple question.

Mr. Miller was speaking at a conference titled "Credit Cycle-What's Next?" in the auditorium of Deutsche Bank in New York. During a 40-minute session, Mr. Miller along with other experts spoke to more than 200 top-tier Deutsche Bank clients about the markets. In particular, he talked at length about why this is a great time to buy financial stocks -- including Bear Stearns Cos.

Burned by Bear Stearns: Bill Miller of Legg Mason
After the presentation, an audience member raised his hand and asked Mr. Miller if he was aware that Bear was collapsing and its stock was down 15% that morning. Mr. Miller looked shocked, according to observers…..

Bear Stearns is emerging as the latest disaster for Mr. Miller, who has also taken a bath on home builders like Pulte Homes Inc. and other financial companies like Countrywide Financial Corp., while missing out on big gains in energy in recent years.

Seems Mr. Miller is not alone among the fallen investment stars
The sudden decline illustrates how quickly the credit crisis is transforming celebrity investors into laggards, as their traditional down-market playbooks are failing. The setback is particularly stinging for Mr. Miller, who has thrived in the past by assembling a portfolio that is very different from other value investors.
Actually, for years Miller’s portfolios had little in common with what is generally considered a value investing strategy as he has loaded up on high p/e stocks like Amazon.

In fact Miller’s decline wasn’t particularly sudden and gives rise once again to the reliability of a strategy of picking funds run by investment “superstars”
Mr. Miller was similarly ahead of the index over the past 15 years on average. His streak concluded in 2005, however, and his fund was down 6.7% last year while the S&P 500 was up 5.5%, including reinvested dividends. Over the past five years, his fund has averaged just 6% annually, little more than half the return for the S&P 500, says Morningstar.

Even when investors were seeing strong performance from Miller’s fund they were taking quite a bit of risk. Miller’s portfolios are marked by large positions in a small number of stocks and often a high concentration in a particular industry
Reviewing statistics for Mr. Miller’s fund (LMVTX) one finds that his fund has a 5 year standard deviation of 14.6 and a return of 8.02%. The Vanguard Total US Stock Market Index (VTSMX) had 9.63 and 11.5% respectively. This means that the Miller fund was s more than1.5 x more volatile than the market index yet produced less return. For ten years the lmvtx beats the vtsmx in return by a small amount 4.83 vs. 4.46 but with considerably more risk. The ten year standard deviation for the Miller fund is 19.8 vs. 15.23 for the total stock market index.

As noted, Miller’s fund has consistently held concentrated positions making it far less diversified than a market index fund. The top ten holdings of the total stock market index fund comprise 16.1% of its assets. Here are the numbers for the Legg Mason Value Trust:


Company Symbol % Assets YTD Return %
6.91 -30.41
6.20 -15.94
5.93 -20.14
5.20 -14.08
4.73 -6.03
4.10 -21.89
3.91 -45.85
3.46 -20.58
3.43 19.43
3.18 -31.87

Whatever Miller’s future performance it is clear that it will be the result of taking on quite a bit of risk:

Regarding recent missteps, Mr. Miller is essentially re-employing his strategy from the early 1990s -- an important reference point that's informed some of his boldest buys.
Back then, a similar crisis was unfolding in financial markets and Mr. Miller eventually swooped in to buy money-center banks like Chase Manhattan and Citicorp that he thought were underpriced, as well as insurance companies and mortgage lenders. Financials made up as much as 45% of Mr. Miller's portfolio by the mid-1990s, and helped drive his 15-year winning streak as they rallied over the years…..

Mr. Miller bought financials like Washington Mutual Inc., Wachovia Corp., Merrill Lynch & Co. and Freddie Mac in recent months. He added Bear, Goldman Sachs Group Inc. and NYSE Euronext in the third quarter. Despite gains in recent days, the financial sector of the S&P 500 is down 15% this year.

Mr. Miller is sticking to his guns. Legg Mason Capital Management was the largest holder of Countrywide through December, holding about 12% of company shares. While the stock was the worst performer for the fund last quarter, down 53%, Mr. Miller is betting it is a great buy for Bank of America Corp. in the long run. Mr. Miller was so eager to keep buying the stock, in fact, he petitioned the Office of Thrift Supervision so he could increase the stake to up to 25% of shares outstanding. The permission was granted in mid-January, and he increased its holding.

My conclusion from all this is that once again it is clears that:
1. There are no geniuses: even investment superstars inevitably run into the reality of how difficult it is to beat the market.

2. Even when it seems like a superstar is “crushing the market” he or she is almost surely doing so by taking on far more risk than the overall market.

3. Which means that eventually we will see the consequences in #1 above.

4. Hope springs eternal and articles will soon appear about the new superstar with a track record of crushing the market indices.