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Learning From Bill Miller's Recent Underperformance

by: Kevin Price May 16, 2008    

Kevin S. Price

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In yesterday's reading list, we included a recent New York Times piece on Legg Mason's Bill Miller, the renowned fund manager whose flagship fund beat the S&P 500 for 15 consecutive years, from 1991 through 2005.

The story's premise -- that Miller has been chastened a bit by his fund's recent underperformance -- is fascinating enough as a study in manager psychology. More interesting (to us, anyway!) is the fact Geraldine Fabrikant's piece features a few arguments that we've made repeatedly in this space.

First, there's the big picture phenomenon of reversion to the mean. In relatively efficient markets, it's just enormously difficult to sustain significant departures from the performance of a fund's underlying asset class. Many efficient-market absolutists will suggest that Miller's successful run may well have been little more than coin-flipping luck. With so many managers in the field, they might say, a small number of coin-flippers will come up heads 15 times in a row. We think there is such a thing as investment skill, often more temperamental than technical. But we fully acknowledge that luck is part of the game as well, and we suspect Miller was both good and lucky for many years. There's no reason to suspect he's any less skilled now than he was five years ago, but his randomized draws from the bag full of luck has clearly turned against him.

Second, there are the intertwined problems of asset bloat and market impact. Here's Fabrikant:

SOME longtime market experts think that fund size is the most daunting challenge he faces. Regardless of periodic ups and downs, he may simply be managing too much money to continue to produce outsized gains, they say.

"The number of investment opportunities just shrinks radically" when a fund swells, says John C. Bogle, the founder of the Vanguard Group, the mutual fund powerhouse, who describes himself as a fan of Mr. Miller. "The bigger you get, the fewer the number of stocks you can hold with a meaningful position."

Indeed, Mr. Miller holds a relatively concentrated portfolio, and the bad news has kept coming for some of his major picks. Last week, after Microsoft's proposed buyout of Yahoo fell apart, Yahoo's stock plunged 11.5 percent last week. Legg Mason holds a 6.7 percent stake in Yahoo. Countrywide Financial, another big holding, has been slammed by the mortgage crisis and errant lending. Its stock has fallen 87.9 percent over the last 12 months. And Mr. Miller amassed a sizable position in Bear Stearns, the investment bank gone to the grave.

We remember one of Miller's annual letters in which he freely acknowledged the constraints of running a portfolio that was at once enormous and highly concentrated. (He was aware of the problem then, but, in Fabrikant's telling, seems to dismiss it as a cause of his recent underperformance.) Because asset bloat is a structural problem, there's not much he can do about it, unless he diversifies his holdings. Which he and his team appear to be considering:

At Legg Mason, Mr. Miller has been stress-testing his investment theses -- the way he and his colleagues picks stocks -- and is considering a move away from concentrating his bets on dozens rather than hundreds of stocks.

"The question we are asking ourselves is: Should we think more broadly now about probability, about high-impact events and protecting against them by having broader exposure to the market?" he says.

Which leads us to the third point: Chasing "hot" managers is not a particularly wise game, at least not after they're both hot and pretty much universally recognized as such. Paying managers to pick positions and manage risk actively isn't inherently unwise, but it should be done with great care, and such services should be delivered in products and programs that have a relatively high probability of delivering what investors are paying for.

There can be no guarantees, of course, but piling into enormous funds with a relatively high likelihood of mean-reversion strikes us as an approach that makes a difficult game that much harder.

Source

Geraldine Fabrikant, "Humbler, After a Streak of Magic," New York Times, May 11, 2008

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This article has 16 comments:

  •  
    May 16 04:59 AM
    I'm not sure what you're trying to argue here. If it's impossible to beat the market, perhaps you should close your fund and advise your clients to invest in index funds. Or do you mean that your clients should only invest in underperforming funds so that reversion to the mean will magically make them outperformers in the future?

    Bill Miller was not the victim of bad luck or reversion to the mean. He simply made the mistake of investing in too many turnaround situations, which at this point look like value traps, though some may turn around and result in profitable investments if given enough time.
    Reply
  •  
    May 16 08:41 AM
    "renowned fund manager"
    "legendary fund manager"

    LOL. I love when I see these terms, used to describe a man who can only perform during "bull" markets"

    "that Miller has been chastened a bit by his fund's recent underperformance"

    What? Recent underperformance? His fund is exactly where it was in 1998!! Please read my post from a few weeks ago, and I hope it clears up what Bill Miller is truly about:

    4/3/08
    Bill Miller of Legg Mason is a perfect example of what is wrong with the mutual fund industry and all the conflicts of interest.

    He is actually a lousy money manager who got "lucky" by managing money during the greatest bull market of the 20th century, and with the help of companies such as Morningstar, they made him out to be some genius.

    During bull markets any jackass can beat the market.

    It is during bear markets or not so good markets that truly good money managers excel. Bill Miller's Legg Mason Value Primary may have beaten the S & P during the 2000-2003 bear market, however it did by just a hair each year. Meaning, Miller was paid, to essentially lose 40% of his clients money over that time period while getting paid MILLIONS of dollars.

    That is not money management. How many of you out there have that 100 foot yacht, and a bank account worth 100 million from collecting fees from the money you manage, regardless if you are a lousy manager?

    Bill Miller got lucky betting on a few stocks at a time, and that works in bull markets. It is becoming obvious thru the previous bear market and today's lousy market that Bill Miller's "fame" is nothing more than hype, enabled by the media and Morningstar.

    Bill Miller's Value Trust is exactly where it was around 1998. Thats right, he has been paid millions over the past 10 years and essentially those in his fund have made nothing, unless you were lucky enough to get in, in 2003. And even there he is on his way to breaching those levels. All that money he was paid and the fund has a 10 year annualized return of less than 4% which is less than a percent more than the S & P 500 over the same period.

    The man is given to much credit for a lousy job and should be "returning money" to investors out of his own pocket for his lousy performance.
    Reply
  •  
    May 16 09:47 AM
    Funny, I never see articles like this about Hussy, er, Johnny Hussman, here on Seeking Alpha.

    This despite his "recent" five-year underperformance vs. the market.

    Hussy can only outperform in BEAR markets, which is the flip side of what archman82011 believes about Miller.

    Matter of fact, from Jan 2003 through Jan 2008, Miller's fund outperformed Hussman's.

    From Jan 2003 through TODAY, both Miller and Hussman have underperformed buy and hold the SPY.

    Perhaps both men are given TOO much credit for the lousy jobs they're doing ...
    Reply
  •  
    May 16 09:59 AM
    The best part about "hot managers" like Miller, or John Henry, et. al. is that they almost always destroy more wealth investors than they ever created. Their poor performance always seems to come when the asset base is at its maximum.
    Reply
  •  
    May 16 10:00 AM
    NO DooDahs:

    Agreed. One the one hand you have the guys who are always negative and when the market is bad, they make decent money, only to have mediocre performance when things are good.

    Then you have guys like Miller, (and not to only pick on Miller, 95% of fund managers out there) who can only make money during bull markets.

    Bear markets, though painful, and even sideways markets, in my opinion, really separate the men from the boys.

    What is sad about that statement, is that it is obvious that 95% of fund managers are just grossly overpaid boys, playing with fund holders money as if it was play money. If the mutual fund industry was a "performance"... based fee structure, you would not have the abuse of fund holders money, like you have now.

    But alas, most american investors are lemming, and are happy to sit back and watch these fund managers get paid millions while there money has essentially done nothing for the past 10 years.
    Reply
  •  
    May 16 10:23 AM
    If only he could have made his streak last another 10 years or so, his fund would have become a self-fulfilling legacy like Buffett where he could beat the stock market by just announcing his stock purchases, and wait for the public to rush in to mimic him driving his performance higher and higher.
    Reply
  •  
    May 16 10:29 AM
    This is from Plato: the people always have some champion whom they set over themselves and nurse into greatness. I tend to fly away from these champions (but not from WB because he doesn't behave like one).
    Reply
  •  
    May 16 10:55 AM
    I don't get how so many people can be so blind. Miller manages a VALUE TRUST. Any idiot can beat the S&P 500 when they are buying ENORMOUS STAKES of GOOG and YHOO! The fact is that Miller's funds have beat the S&P in the past because the S&P was NOT an accurate gauge of performance, as the riskiness of his portfolio was higher than the S&P and was NOT comparable.

    When you hear the praise of the media making ridculous and unfounded claims that he has beaten the S&P for 15 years, you need to investigate whether his holdings and percentage of holdings is in fact comparable to the S&P 500.

    Bill Miller is not impressive. he has benefited from Legg Mason's huge marketing that has made inaccurate claims which have fooled the investment public, most of which who are clueless.
    Reply
  •  
    May 16 11:16 AM
    I was a broker at Legg Mason in 1985. At its inception, the Value Trust was run by Ernie Kiehne. Ernie used to quote his cats on institutional research calls. To say he was eclectic understates the definition of the word. Ernie was a one of a kind manager and we loved him. He told me once he calculated the value of his fund every day on the way home on the bus and would get within a few points of where the computers pegged the fund. (yes he rode the bus.) Ernie was responsible for the early out-performance of the fund, because the brokers at Legg believed in him. Bill Miller initially ran what used to be called the Legg Mason Special Situation Fund. The Special Situation fund reflects what Miller has done with Value Trust since he took it over in 1990. Kiehne had a far more tradtional view of what a "value" stock was. Miller's value calculations were always more progressive shall we say; more relative value. Miller has also run the Value Trust in a more concentrated manner; perhaps taking a page from Buffet who has in the past said, (I'm paraphrasing,) that while a manager may have many stocks in a given portfolio, out-perfromance is a function of having a core and concentrated position in the right stocks. It is difficult for any manager to out-perform over time. The issue for Miller and the Value Trust is did Miller's concentrated positions and progressive definition of "value" finally catch up with him. What may be different now is that Legg Mason is not the firm it was when Miller made his run. For years, Legg Mason was a tightly focused brokerage with a solid group of asset gatherers who fed the firm's asset managers a steady stream of new money. Miller now faces a different dynamic. He's got a big fund with a performance issue but now lacks that dedicated support from brokers who felt a strong connection to the fund. Who is going to hold all that money in place now?
    Reply
  •  
    May 16 11:22 AM
    Mike Stathis:

    Amen. Like I said in my post, Miller may have "beaten" the S & P 500 from 2000-2003, but a look behind the numbers, shows he did so only by a few percent each year. So essentially, he lost 40% of his clients money anyway, while making a mint for himself.

    Your point about marketing is dead on. For instance, companies like Morningstar claim to be independent. What a crock. They are the biggest pump monkeys of bad funds and stocks out there.

    Why does all this go on? For one reason and one reason alone.

    Zero Accountability.

    Will that ever change? Nope. Not that I can see. Why? Because the public, is so dumbed down and bombarded with information from Wall Street, in an effort by Wall Street to keep the average american utterly confused. And what do most people do when they are confused to the point they are frozen? They simple throw their hands up and invest blindly just to get the problem out of the way.

    That is why nothing is ever going to change on Wall Street and in the mutual fund industry.

    The entire mutual fund industry should be set up similiar to hedge funds. The fund managers should get paid for "performance"... only, and there should be no asset management fees. And I mean a small fee, nothing more than 1 or 2% tops of returns. So the managers only get a small portion of the returns and not a fee at all for asset under management. That would kill these pathetic "asset gatherers" and make them earn their pay.

    And when they have a bad year, they have to recoup the losses first before they get paid a new cent.

    But alas, it is but a dream.
    Reply
  •  
    May 16 01:57 PM
    So get away from these mutual funds. Invest using Exchange Traded Funds, with asset allocation and periodic rebalancing. Take a look at marketriders.com.
    Reply
  •  
    May 17 08:07 AM
    Bill Miller is a complete jack ass...and yes he got lucky. He buys bad stuff and just holds it, as opposed to Ken Heebner of CGM Focus...he is in and out of stuff fast, thats why I'm in his fund...and its the only fund I own. Miller is dope, who holds bad smelly stuff and does not use stop losses...WHAT A MORON BILL MILLER IS. He's toast, done!!!!
    Reply
  •  
    May 17 12:50 PM
    Aside from the unneeded ad hominen attack on Miller, Jack Swanson is right about Ken Heebner, one of my personal investment heroes. As fund manager myself (MTRPX) (outperforming 96% of my ;arge cap growth peers over the past five years) I know from practical experience that low turnover buy/hold managers almost inevitable revert to the mean. Heebner has been criticized--wrongly--b... ignorant observers who decry his mad bomber high turnover concetrated style. The reality is that he has forgotten more about investing than most 'pundits' ever knew. Especially the English Lit majors at Morningstar. It is my unceonventional belief that a good track record accopaied by high turnover is much more projectable into the future than a good record acheived with low turnover. Why? Ask yourself, which .300 hitter would you send up to pinch hit in the bottom of the ninth: the one who is 3 for ten, or the one who is 50 for 150? More sucessful data points give you a better chance at future results, right? The fund industry rpomotes low turnover solely because most successful funds are simply TOO BIG to move rapidly and frequently. It like the 350 pound guy who pooh-poohs working out--not bacause its bad, but because he couldn't do it even if he wanted.
    Reply
  •  
    May 18 06:17 PM
    Thank god for the Internet. It allows us to track the real performance of these blow-hard money managers, read archived interviews, hyperlink to their lousy past predictions, and demonstrate that even with a room full of computers, analysts, and public relations personnel, most of these fund managers are a waste of fees. I remember the Money Magazine puff piece done on Miller last summer.

    money.cnn.com/2007/07/...

    How about this gem? I remember CNBC focusing on this "legendary investor" and his buying of beaten down financials and home builders to imply that a "comeback" was near! The idol worship of lucky gamblers, in the face of undeniable economic realities, and the search capabilities of the internet, a thing of the past.

    www.fool.com/investing...
    Reply
  •  
    May 18 07:07 PM
    <<Aside from the unneeded ad hominen attack on Miller, Jack Swanson is right about Ken Heebner, one of my personal investment heroes. As fund manager myself (MTRPX) (outperforming 96% of my ;arge cap growth peers over the past five years)>>

    Hey Bob Markman:
    Yeah you outperformed over the past 5 years. Oh shoot wouldn't you know it, the market has been in bull market mode for the last 5 years.
    I wonder if you are like all those other over paid asset gatherers that can only make money in bull markets??

    Lets see how you did from 2000-2003.

    Well what do you know, your fund lost:
    -26% in 2000, -23% in 2001, -26% in 2002?
    LOL. You call that money management? You are just another fund manager who can only make money in full blown bull markets.

    In bear markets, because you have no idea how to protect your "clients" money, you lose their money. Nice return so far for 2008:
    down 17%!!!

    You sir are an embarrassment, and to use this forum as a medium to pump your pathetic fund shows just how much of a Wall Street criminal you are.

    Shameful!!!!
    Reply
  •  
    Jun 25 10:52 PM
    On Bill Miller, he's a monkey with a typewriter:

    wcvarones.blogspot.com...

    On Bob Marksman, 50 for 150 is not a .300 hitter. Do the math.
    Reply
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