Invest in soundness of a fund manager, not his streak

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January 09, 2007|By Charles Jaffe | Charles Jaffe,MarketWatch

About eight years ago, Michael W. was looking for ideas when he went to an investor conference in his native New Orleans.

Trying to pin down a speaker for names of good funds, he asked: "Which fund managers do you admire?"

The answer was a short list, and Michael most liked what he heard about Bill Miller, who at the time was halfway into a streak that saw his Legg Mason Value Trust outperform the Standard & Poor's 500 for 15 straight years.

Miller's streak ended with the close of 2006, as Legg Mason Value Trust finished the year more than 9 percentage points behind the benchmark.

So Michael sought out the same speaker for some new advice. Reminding me of the original talk, he asked a question that a lot of Bill Miller fans most likely are curious about: "You talked about Bill Miller's streak, and that's why I bought his fund," Michael wrote. "Now that the streak is over, I want to know first if I should get out, and second who is going to have the next great streak."

The streak was the wrong reason to buy the fund, and its end would be the wrong reason to sell it.

Investors looking for the "next Bill Miller" by searching for funds with streaks that might someday grow as long are looking for the wrong thing.

That doesn't diminish Miller's accomplishment, but investors need to keep it in perspective.

For example, had you measured the fund on a fiscal year beginning July 1, rather than on a calendar year, Miller's streak never would have reached the point where it became particularly noteworthy. There were plenty of 12-month periods where the fund trailed the market, sometimes substantially, but none of those performance stretches had a start date of Jan. 1.

And if you wanted the fund not only to beat the market but to be profitable each year, forget about it; while Miller beat the market in 2002, the fund was still off by about 19 percent, the fund's third consecutive year of losses.

Morningstar, for example, gives Legg Mason Value Trust (LMVTX) a middle-of-the-pack rating of three stars - with the rating tilted to give extra weight to more recent performance - and Lipper has the fund ranked below-average for "preservation of capital."

While Michael decided to bet on Miller's hot streak, what he was really doing was committing to the man. If you went out looking to pick a solid mutual fund manager, you would look for one with a long tenure, a proven ability to deliver better-than-average results for the asset category, a style they stick to in all conditions - Miller is a dyed-in-the-wool value investor - and a vehicle that gives the manager the freedom to follow his intuition.

The streak might have proved that Miller possessed those characteristics, but he made the streak, it did not make him. That's why the streak itself is no reason for Michael or other Legg Mason Value Trust investors to exit the fund now.

Lost in the hullabaloo of the streak was that the fund has always been volatile. For the past three years, the fund has been a below-average performer in its asset class, according to Morningstar, yet it is in the top 20 percent of its peer group since the start of 2002 and in the top 5 percent of the category over the last decade.

While 2006 was much worse than investors like Michael would have expected - the fund finished behind virtually every fund in the asset class - it was still positive, and those absolute returns were not only mildly disappointing to a large-cap stock investor with reasonable expectations.

One period lagging the index should not have been enough to prove to shareholders that Miller's style was too volatile for their tastes (they didn't seem to mind volatility in 2003, when Miller was equally far away from the pack, just on the up side). By itself, any winning or losing streak is a curiosity, not something to base an investment decision on.

Likewise, there are about five dozen funds that have now beaten the S&P 500 for eight years. Toss out the ones that shouldn't be benchmarked against the broad market - so that the comparison is fair - and you're left with about a dozen contenders for Miller's crown.

My favorite contender, since Michael asked, is Cambiar Opportunity (CAMOX), where manager Brian Barish has beaten the market since the fund's inception. That's no guarantee he can continue to do it, but it says that eight straight years of using a distinctive style to top the market makes a fund worth examining, if only for the shareholder to decide that the issue deserves the same kind of faith and trust that Bill Miller has earned for the past two decades.

Charles Jaffe is senior columnist for MarketWatch. He can be reached by mail at Box 70, Cohasset, MA 02025-0070.

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