Wednesday, July 16, 2008

“Dear Bill….”: A Letter to Bill Miller, Manager, Legg Mason Value Trust

Dear Bill,
I hope you are well these days, I understand it’s been a difficult time for you lately, and I’d imagine you’ve had many sleepless nights. I trust that there are better days ahead for you. I hope for your sake, as well as for others who have trusted you with their money, that this is indeed the case.

When I hired you several years ago to manage a nice chunk of my retirement portfolio’s large cap allocation, I did so knowing that our investment philosophies are quite different. We view “value” in very different terms, but that was ok. I understood the differences, and I took the risk. I was actually quite pleased that my company’s 401K plan brought you aboard.

We had a great run, Bill. In fact, your streak began years before I hired you, and I certainly did not expect it to continue forever. After all, how many managers beat the S&P 500 Index 15 consecutive years? You did, Bill. But just like all streaks, yours came to an end. Unfortunately a very abrupt and painful end; more painful than either of us could have ever imagined.

When I hired you, I never dreamed I’d be writing you this letter. But after a great deal of thought, it pains me that I am hereby replacing you as my primary large cap manager. I can no longer take the risk that your investment process is indeed broken, or is no longer effective.

I know, Bill, every active manager hits bumps in the road, and the market environment has been extremely difficult. But your underperformance the past two years has gone way beyond normal market gyrations.

How is it possible that you are down 32% year to date, or 39% over the past year? Looking back, do you think that your positions were too concentrated in financials? Yes, Bill, I know hindsight is 20/20, and I sound a bit like Captain Obvious here, but Bear Stearns, Washington Mutual, Citigroup, Merrill Lynch, Freddie Mac, AIG, Countrywide? Where was your risk control? Was it deep conviction or wishful thinking on your part that financials would turn around? I know that what has transpired over the past couple of years in financials was essentially the perfect storm, but I hired you because I trusted that you’d be able to navigate even the worst market events. I certainly never expected things to turn out like this.

Unfortunately, your recent performance has been so devastating that it essentially renders your 15 year streak irrelevant. Over the past five years, you’ve underperformed the S&P 500 by more than 800 basis points…per year. Over the past ten years, you are under 90 bps per year. You have to go back to 1996 in order to find a multi-year period (through now) that you’ve outperformed. Guess I should have indexed large cap all along. My bad.

Unfortunately Bill, what many investors fail to understand is that average returns are meaningless. What truly matters is the time path of returns, i.e., the order in which returns occur. Your huge losses the past couple years all but wipe out the previous gains your shareholders enjoyed.

Finally, Bill, just a word of advice about where you are spending your time these days. I know you want the Yahoo situation to work out to the advantage of your shareholders, and you do hold a fairly large position in the company (4% of your portfolio). But are you devoting too much time and energy to this?

In closing, I can’t place all of the blame on you. I should have pulled the trigger several % ago. I admit I got too caught up in “Bill Miller: The Legend”.

Bill, best wishes for the future.




Eric J. Fox said...

The amazing thing is that Bill maintained his streak while shunning the Energy Sector.

Anonymous said...

I suppose this just reinforces the argument for indexing, especially in the mid/large cap universe of stocks. Compare this fund to IWD (the Russell 1000 value index), or even better yet, IWN (the Russell 2000 value index). Either of these would arguably be better choices, and with lower fees.


Henry Bee said...

Jon, it seems to me that you have capitulated with the crowd, selling a fund positioned for outperformance should the great momentum versus value trend reverse. This is a terrible mistake.

Anonymous said...

You could have written that same letter to Charles Munger at the beginning of 1975. In 1973, Munger's partnership was down 31.9% (vs 23.1% for the Dow) and in 1974 his partnership was down 31.5% (vs 13.1% for the Dow).

Of course, you would have missed his best year ever, when in 1975 he was up 73.2%.

Anonymous said...

...Miller’s often quoted as saying “Lowest average cost wins.” If he likes a stock at $40 and it drops to $30, he likes it even more and often keeps buying as it continues to sink.

- at the end of the day, once you throw out all the millerite jibberish designed to wow and impress while adding a shroud of black box mystery, below avg bill's (BAB) invstmnt philosophy really boils down to two things: 1) a CONCENTRATED BOOK, and 2) LACW (lowest avg cost wins).

dividing his 18 yr career into two time periods, 1990-1998, and 1999 to present we see two distinct performances. the first was better than avg, the second was much below avg and was a negative cagr when considering inflation.

it is very clear that the first period was deep in the heart of a incredible secular bull market, where a very accomodative and reckless fed lifted a lot of boats (or utopia-like yachts in below avg bill's caase). in such a bull market, where speculation and sentiment rule the day, LACW works wonderfully as even those reckless and foolish enough to buy lousy businesses with shoddy accounting and corrupt managers got bailed out in spectacularly when the bail-outs came.

applying concentrated LACW during the second phase of his career, aka a secular bear is and will be absolutely DISASTROUS for his shareholders and for making adjustable rate yacht payments - "when the tide goes out we see who has holes in their yachts."

the irony now is BAB blames the fed for his countrywide and bsc disasters, when he benefitted tremendously from uncle alan during phase I of his sorry career. iow, when you buy a reckless, corrupt business that is levered 30 to 1, and has sucked money from shareholders for years, it is not your fault for being an idiot and employing concentrated LACW, but rather the fed's fault for not interferring enough to bail you out. what is his excuse for enron, or ek, or the mortgage insurers, or homebuilders?

there is none. concentrated LACW is nothing more than recklessly buying poorly managed businesses and will continue to drag down his performance.

the trick is to buy a fractional interest in a good business at a good price. this is very unlike BAB's philosohy, which is to not have a clue regarding i.v., and to try to bail yourself out of this problem by relentlessly avging down (i once studied south american wasps colonies and discovered that the market like the wasps have a tendency to overcorrect to the downside penalizing companies' share price below i.v.). making it worse is he is doing this in companies that have no MOATS run by mngt that is decidely unfriendly to shareholders.

if BAB submitted this resume and his concentrated LACW philosophy to brk to apply for the cio opening, surely it would promptly be tossed in garbage. but if by some miracle, he got the job, i would sell every share of brk i own that same minute.

no one will hold onto their lmvtx shares now. they are all jumping ship. the millerites remaining who support this clown must drink the kool aid and sail on uptopia with him...or they are helpers. probably the latter.

Anonymous said...

How is that amazing that he had a streak without holding much in the way of energy stocks? He outperformed the market when energy was out of favor...once it picked up he barely held up and once energy really took off he completely failed.

The thing that kept me away from Bill Miller was 2 fold. 1) most of his 'streak' was based on calendarized performance. When looking at his performance at other time periods (ie July 1st to July 1st) he didn't have many multiyear streaks. The other reason I hesitated to join his fund is that everyone else was joining him because of this "streak" - and that means people pull away very quickly, as they have, once he starts missing. Which usually exagerates the negetive returns.

Besides I never did see how he was much of a "value" investor, he seemed to hold growth companies mostly.

david said...

Bill Miller made his $ by applying value principles to technology companies. Most value investors believed that this was too hard to do.

He seems to have been correct.
Was Bill Miller smart or lucky? I think he was 75% smart and 25% lucky.

Most value investors also feel that financial companies are too hard to really understand. Bill Miller has bet big that he can understand them.

Just because one bet on Bear Stearns turned out poorly doesn't mean that his strategy is wrong; he could achieve massive gains on 70% of his investments and massive loss on 30%, and still come up huge.

I stand with most value investors in my belief that financial companies have assets that are impossible to value.

stocksystm said...

The term value in Legg Mason Value Trust was definitely a misnomer. I think we just need to admit that Miller was one out of the many thousands of fund managers who happened to flip heads a lot more times than the others. In other words, he was simply extremely lucky. Like all gamblers, his luck finally ran out.

slickvguy said...

He's not the only one. Many so-called "value managers" have taken unexpected big hits over the past few years. It's now apparent that most of these guys just had good luck rather than skill. Whenever the market sold off, they would buy, and the market came back. They don't seem able to discern between a relatively lower price and a truly CHEAP valuation. Unfortunately for them and their investors, this time the market didn't come roaring back. In fact, teh opposite happened. You didn't see WEB buying those financials - did you? He kept his WFC, and look how well that has done relatively speaking.

You can't blame them for making mistakes, but you can blame them for not managing risk properly. It is not their job to take large bets to save face - and that is exactly what they did. Faced with a loss of reputation and bad performance, they PUSHED it, and lost. They have no right to do that with OTHER people's money.

Just one more reason to go with passive investing.