Hindsight is 20-20

Legg Mason's legendary fund manager tells investors why they shouldn't panic over his fund's lapse in performance


August 13, 2006|BY A SUN REPORTER

Baltimore investment guru Bill Miller has made a lot of money for a lot of investors over the years with his astute management of the Legg Mason Value Trust. But sometimes, relentless market forces can set back even the most agile investment mind.

So it was that earlier this month Miller found himself explaining in his quarterly letter to shareholders why the Standard & Poor's Composite Index, a garden-variety measure of overall stock market performance, was actually outperforming the vaunted Value Trust.

A share of Value Trust, which provided investors with a remarkable 15 percent return over the the past five years, declined 5.67 percent in the quarter while the S&P 500 Index dropped just 1.44 percent. For the first half of this year Value Trust was down 5.07 percent while the S&P 500 rose 2.71 percent.

For Miller, who is famous for outperforming the S&P 500 every year for the past 15, the question loomed - was his long run of investment success in danger of ending?

Miller, who is well known for his lively market commentary, rose to the challenge, describing himself as an investor, not a trader, indifferent to short-term market trends and urging his clients to take a longer view.

Whether that argument will play with investors previously wowed by Miller's continuous success is likely to depend in part on how he does in coming quarters.

Here is some of what he had to say:

"We had a dreadful second calendar quarter. We have been doing this a long time and have been here before (way behind the market), but for those who are newer, or nervous, or whose psychological equilibrium is disturbed by non-linearity, some context might be helpful. ...

"There are four main reasons why the portfolio is currently trailing the S&P 500. The first has to do with our [investments in] the Internet names which include Amazon, eBay, Yahoo, Expedia, Interactive and Google. These names started the year at roughly 20 percent of the portfolio. ...

"In our view, these companies represent superior economic franchises with the ability to earn above the cost of capital as far as the eye can see, and the market's myopic, obsessive focus on what is going on for the next three or six months doesn't alter the business value. Price and value are two different things. We estimate the intrinsic business value of Yahoo, Amazon, and eBay at up to more than double the current price, depending on the company, and that is current value, not what the value is likely to be in several years. ...

"The second source of poor performance was due to our exposure to [investments in] the managed care industry. ... These companies, United Healthcare, Aetna and Healthnet, have risen close to 300 percent over the past five years while the market is up a little over 13 percent over the same time period - and this performance includes the last six months of poor relative returns!

"The third area where we have not fared well has been in homebuilding, where our exposure is roughly 5 percent of the portfolio. Here we clearly made a mistake by initiating positions too early. ...

"Finally, our continued lack of [investments in] energy. ... This is another area we were clearly wrong about (isn't hindsight useful?). The call is much harder from here, with only scattered Stone Age tribes in the Amazon, the comatose, or newly arrived aliens from Alpha Centauri, unaware that energy stocks are a one-way ticket to [better-than-average performance]. ...

"We are long-term investors and not traders. ... Our contrarian approach often puts us at odds with the prevailing views in the market. When our approach leads to underperformance, such as in the current market, there is increasing pressure to change or do something different. ...

"It is our willingness to own securities which other people regard as wrong which historically has been part of the long-term success of the fund. In order to do better than the market longer term, you must be doing something different and ultimately have the market recognize the values one believes are inherent in those companies."

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