Two years ago, Bill Miller was the toast of the mutual fund world. His Legg Mason Value fund was on the verge of completing an unprecedented 15th consecutive year of beating Standard & Poor's 500-stock index. The streak brought fame and fortune to Miller and to Legg Mason.
Then his Midas touch deserted him. Last year, Value trailed the S&P 500 by a hefty ten percentage points, finishing in the bottom 1% of large-company blend funds, according to Morningstar.
The past two years have undermined Value's longer-term record. The fund now trails the S&P by an average of six percentage points per year over the past three years and two percentage points per year over the past five years. Ugh!
I don't think Miller has been playing football without a helmet. He's one of the smartest and most intellectually curious people managing money today. In a conference call the other day, he sounded as sharp and as confident as ever.
If you look beneath the surface, Miller is doing the same things that he has always done. For now, they're failing abysmally, and they may continue to fail for some time. But, in my view, Legg Mason Value (LMVTX) and Legg Mason Opportunity (LMOPX), a member of the Kiplinger 25, are both keepers. Better than keepers: Indeed, this is an ideal time to invest in them.
The streak -- Miller's incredible record against the S&P -- stemmed partly from the fact that Miller defines value investing differently from almost anyone else. His idea of value is any "mis-priced stock," whether it has a price-earnings ratio of 7 and he think its earnings will increase 12% next year, or whether it has a P/E of 35 and he thinks it's a 50% grower.
That means he buys what are traditionally considered growth stocks as well as classic value fare. Thus, when value stocks fell from favor, Miller's growthier stocks kept him ahead of the S&P. Likewise, when growth stocks are out of favor, his value stocks buoy the overall portfolio.
But hidden by the consistency of the streak is the real reason both for Miller's long success and for his failure over the past two years: Miller is the most stubborn investor I've ever known.
His stubbornness is a direct outgrowth of his hard work. He and his analysts (including co-manager Mary Chris Gay) study a stock so thoroughly that by the time they buy it, Miller feels he understands it better than anyone else. When Wall Street comes to a different conclusion, Miller buys more.
Miller hasn't kept this private. Asked for his secret sauce, he has repeatedly said: "The manager who has the lowest average cost wins."
Time after time, I've watched Miller average down in a stock -- that is, buy more of it as it declined. When other investors, professional and amateur, bail out, Miller loads up.
The payoff is almost never immediate; Miller often looks like a fool -- for awhile. But he gets the last laugh often enough to still have a terrific long-term record.
Value is still ahead of the S&P over the past ten years by an average of two percentage points per year and over the past 15 years by 3.5 percentage points per year.
So what does Miller like now? Not surprisingly, financials and the consumer discretionary group (which includes home builders, automakers and other products that aren't considered essential) -- two sectors with poor outlooks.
"The market has already discounted a very bad case in financials and consumer discretionary," he says. He compares the environment today with the savings and loan crisis of 1989-90: the last time he trailed the S&P two consecutive years. "We had a great year in 1991," says Miller. "I think you'll see the same thing happen today."
Miller says the economy will slow markedly next year -- both in the U.S. and abroad -- and that the decline will extend to emerging markets. That, he predicts, will trigger declines in the prices of oil and other commodities.
Before the debacle in financials, which was brought on by falling home prices and the collapse in value of many securities backed by subprime mortgages, Miller's refusal to buy commodity stocks was a major reason for his rotten performance.
As the Federal Reserve brings down interest rates and does whatever else is necessary to restore faith in the credit markets, "I think financials will have a great recovery next year." Indeed, he thinks financials bottomed in early December.
His favorite stocks include mortgage giant Countrywide (CFC) and homebuilders Centex (CTX) and Pulte (PHM), as well as Amazon (AMZN) and Google (GOOG).
Financials and consumer discretionary stocks "are down a ton already," while emerging-markets and natural-resources stocks have been leading the market. "We could have a market next year that's almost the inverse of what we had this year," Miller says.
Personally, I don't buy Miller's short-term forecast. With the economy apparently weakening, I'm not sure we're even halfway through the problems in financials. My hunch is that Miller is early in calling the bottom for these stocks.
Indeed, he made strikingly similar predictions for financial stocks last August. (And in the interest of full disclosure, I have encouraged readers to buy Opportunity several times in the past two years.)
But that doesn't keep me from continuing to recommend Legg Mason Opportunity -- his newer, more nimble fund, which has beaten Value every year since Opportunity's inception in 1999. Opportunity gained 13% last year and is down just 1% so far this year.
I also like other funds that favor energy stocks and emerging markets -- areas that Miller is avoiding. As a fund investor, I don't have to agree with the short-term bets of the funds I own.
What I do have to have is confidence in the long-term judgment of those managers. And there are very few that I have more confidence in than Miller.
Steven T. Goldberg (bio) is an investment adviser and freelance writer.
Steve has been writing for Kiplinger's for more than 25 years. As an associate editor and then senior associate editor, he covered mutual funds for Kiplinger's Personal Finance magazine from 1994-2006. He also authored a book, But Which Mutual Funds? In 2006 he joined with Jerry Tweddell, one of his best sources on investing, to form Tweddell Goldberg Investment Management to manage money for individual investors. Steve continues to write a regular column for Kiplinger.com and enjoys hearing investing questions from readers. You can contact Steve at 301.650.6567 or sgoldberg@kiplinger.com.
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