Has Miller's fund outgrown his touch?

April 19, 2006|By JAY HANCOCK | JAY HANCOCK,SUN COLUMNIST

Is it time to close Legg Mason's flagship mutual fund, Value Trust, to new investors? A good argument can be made that the answer, at least for current investors, is yes.

The famous fund, jockeyed by the even-more-famous Bill Miller, has beaten the Standard & Poor's 500 big-stock index for a record 15 years in a row. If you had put $1,000 into the fund in 1991 your stake would be worth close to $10,000 now.

Value Trust is a cash cow for Legg Mason and an important piece of merchandise for the former Legg brokers who got swapped to Smith Barney last year.

But big market successes often sow the seeds of their own disappointment, and this applies to hot money managers as well as hot stocks.

Legg's investment pros love abstruse theory. So surely they know the statistical law of large numbers, which says that when a sample of a larger group gets bigger and bigger, the behavior of the sample conforms more closely to that of the group.

That's a fancy way of saying that the more S&P 500 stock that Value Trust absorbs, the harder it's going to be for Value Trust to outperform the S&P 500.

Value Trust contains $20 billion in assets these days, and that may be too much dough for Miller to invest in the focused style that has made him a market-beater.

Of course, $20 billion is a teeny piece of the $12 trillion total value of S&P 500 stocks. Miller points out, in a written statement, that many successful "managed" (non-index) funds are bigger. Fidelity Investments' Contrafund had $65 billion in assets last month when it announced that it would bar new investors, to focus on working for existing shareholders.

Certainly it would be wrong to besmirch Miller as a "closet indexer" - the type of money pilot who stealthily aims to match the S&P 500 while pocketing fat management fees for trying to beat it. He makes big, bold bets on relatively few stocks.

At the end of last year - the most recent information available - just 10 stocks made up 45 percent of Value Trust's holdings.

But that in-for-a-penny, in-for-a-pound approach will itself make it tougher for him to perform as the fund grows. These are enormous positions, even if they are typically taken in even-more-enormous companies, "the largest and most liquid portion of the global securities markets," as Miller notes.

For example, at the end of the year Legg Mason - Value Trust and other funds - owned a fifth of all Eastman Kodak stock, said Dan McNeela, associate director of fund analysis at Morningstar.

"That's a huge ownership in the company," he said. "If they decide for whatever reason they wanted to sell it, it's hard to believe they could get out of that position without sending the price down."

Fidelity's Contrafund, by contrast, can be huge because it takes smaller positions in many more companies than Value Trust does.

At the same time, Miller's responsibilities at Legg are changing, which summons the question of whether he will keep his hand firmly on the Value Trust tiller. Last month he moved from chief executive to chairman of Legg Mason Capital Management, a division of Legg Mason, ceding his CEO duties to Kyle Prechtl Legg, who had been president. At the same time, Mary Chris Gay was named assistant portfolio manager to Miller.

And he manages tons of other money besides Value Trust.

Legg Mason has no plans to hang a "Closed" sign on Value Trust. Its money-management team "believes the fund can comfortably manage substantially greater assets than those presently under management," says Miller in his statement to me. Value Trust's low turnover will help.

But don't be surprised if the fund hits head winds. It barely beat the S&P 500 last year, nosing it by less than a percentage point. And Value Trust trailed the S&P 500 for the first quarter, falling slightly while the index gained 4 percent.

Even Miller is preparing investors for the end of the "streak."

If you bought Value Trust because of its 15-year record of beating the index, "we are flattered but believe you are setting yourself up for disappointment," he wrote a couple of months ago to shareholders.

The streak is "a fortunate accident of the calendar," he added, noting that there would be no 15-year streak if the investment year ended in any month but December; in some years, Value Trust trailed the index in the 12 months ending in January, February and so forth.

Legg Mason itself will join the S&P 500 index, it was announced last week, a fitting tribute to boss Chip Mason's career of building the company. A big reason is the success of Miller and Value Trust. It would be ironic but appropriate to the law of large numbers if Legg's admission to the S&P club marked the year its top fund failed to beat it.

jay.hancock@baltsun.com

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