Beating the market for 15 years

Let's look at the success of mutual fund manager Bill Miller
Janice Heng

Mon, Jul 09, 2007
The Business Times

BILL Miller may not rank among the Buffetts and Soroses of the world when it comes to being a household name. But the mutual fund manager's 15-year market-beating streak is legendary.

Born in Laurinburg, North Carolina in 1950, Mr Miller graduated with honours from the Washington and Lee University in 1972 with a degree in economics. He joined asset management firm Legg Mason in 1981 and took over equity fund management arm Legg Mason Capital Management in 1990.

The rest, as they say, is history. The Legg Mason Value Trust beat the Standard & Poor's 500 index every year from 1991 to 2005, growing from US$750 million to more than US$20 billion in the same time. Only last year did Mr Miller's streak finally come to an end, with the Value Trust's 5.85 per cent return trailing the S&P 500's 15.75 per cent showing.

Mr Miller, chairman and chief investment officer of Legg Mason Capital Management, also manages the newer Legg Mason Opportunity Trust mutual fund. In total, he handles more than US$60 billion.

As a self-proclaimed value investor, his strategy is founded on analysis. He buys mainly large-cap stocks that he thinks are trading at large discounts to their intrinsic value, and takes a long-term view on them: not just buying and holding, but buying even deeper into stocks that he holds if their prices fall.

Mr Miller himself has played down the significance of his streak, once saying: 'Our so-called 'streak' is a fortunate accident of the calendar.' Be that as it may, the Legg Mason Value Trust averaged returns of 16 per cent for 15 years up to the end of 2005, a track record not to be scoffed at. What were Mr Miller's strategies in achieving his record-breaking run?

Focus on companies, not trends

Mr Miller begins with the companies in mind, not the market trends. As the man himself has said: 'We don't have a forecast-and-trend approach - meaning we don't make a forecast of what we think is likely to happen, or what trends are likely to occur, and then adjust our portfolio to conform to the forecasts.

'We estimate the intrinsic value of our companies and invest where we can get the greatest discount to intrinsic value. Then we try to understand the environment we're operating in. But we start with valuation - that's always number one.'

A famous example of this approach in action is his bid for Google's initial public offer in August 2004. Back then, the prevailing sentiment held that Google was just another over-hyped Internet play.

Never one to follow the crowd, Mr Miller set up a task force to analyse the company. They developed a three-tier bid based on their valuation of Google, which turned out to be much higher than the final price of US$85 a share - meaning that Mr Miller scored 2.3 million shares at US$196 million. That initial investment is now worth over US$1.2 billion.

Look for value

When Mr Miller assesses companies on their own merits, he also looks at their current price relative to what he thinks is their intrinsic value. Value investors are the bargain hunters of the stock market, and Mr Miller looks for stocks trading at large discounts.

If a stock that he holds starts to fall, he simply sees it as a better bargain. Hence, his famous reply to the question of when he would stop buying a falling stock: 'When we can no longer get a quote.'

Of course, value investors always face the danger of being left with a value trap, or a stock that appears undervalued but is on the decline. Research and analysis is key to avoid ending up with a value trap on one's hands.

In this area, understanding the background of the industry is also important. Says Mr Miller: 'The trap comes in when there's a secular change, where the fundamental economics of the business are changing or the industry is changing, and the market is slowly incorporating that into the stock price.'

Go for the long-term

Mr Miller is definitely not a short-term speculator, and instead sums up his long-term view on stocks as 'creative non-action'.

'We are mostly inert when it comes to shuffling the portfolio around, with turnover that has averaged in the 15 per cent to 20 per cent range, implying holding periods of more than five years,' says Mr Miller.

Market changes seldom affect his decisions, either. 'Many funds have turnover in excess of 100 per cent per year, as they constantly react to events or try to take advantage of short-term price moves. We usually do neither. We believe successful investing involves anticipating change, not reacting to it.'

In the late 1990s, Mr Miller famously bought more and more shares of Internet company AOL, even as its price plummeted. Despite widespread scepticism about the wisdom of that choice, his decision eventually paid off when the stock came back strongly.

Do your own thing

Mr Miller's winning bets on Google and AOL illustrate a key component of his style: never be afraid to think differently.

After all, Mr Miller once served as a military intelligence officer in Europe. He also sits on the Board of Trustees at the Santa Fe Institute, a centre for research in complex systems theory. Though that may sound esoteric, analysing systems is part of Mr Miller's investing philosophy.

'What we are really trying to do is to think about thinking,' says Mr Miller. 'Understanding how groups behave is central to understanding how complex adaptive systems - such as the stock market - work.'

In practice, this philosophy means that Mr Miller often buys stocks which most investors would not consider holding, as he believes that the conventional wisdom about them is wrong. Of course, he is not contrary for the sake of being so: his decisions are backed by solid analysis.

Going long may not sound as exciting as speculation. Yet Mr Miller's style is not for the faint-hearted. Investors wishing to emulate his philosophy, whether in rejecting the conventional wisdom or buying even deeper into plummeting stocks, will need confidence in both themselves and their research.