Insights From a Superstar Manager

Bill Miller isn't just one of today's most talented fund managers. He's also one of the most provocative. His new shareholder letter provides more than the usual number of great one-liners -- and unusual insights.

Miller, of course, manages Legg Mason Value (symbol LMVTX), which has beaten the SP 500-stock index a record-shattering 15 years in a row.

Miller quickly dismisses the significance of the streak: "Our so-called 'streak' is a fortunate accident of the calendar ... If your expectation is that we will outperform the market each year, you can expect to be disappointed."

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Indeed, the fund's winning margin the past two calendar years was minuscule. There's no sign, however, that Miller is losing his touch. His margin over the SP was five percentage points per year, on average, over the past three years; four points over five years; six points over ten years; and five points over 15 years. During that 15-year span, the fund returned an annualized 16% through the end of 2005.

Miller has continued to beat the market even as the assets he manages at Legg Mason Value and similarly run private accounts have swollen to $40 billion. And he continues to prevail despite an expense ratio that has declined markedly over the years but still totals 1.68%.

He calls himself a value manager -- something many other value managers have disputed over the years. They dismiss many of his stocks as requiring pie-in-the-sky assumptions about earnings and revenue growth. He disagrees:

"Was Google good value at $85 when it came public? Well, it appears so, since it is now trading at $436 a year and a half later. [His letter is dated January 19.] But when it came public it was universally panned as another Internet hype stock with all the trappings of 1999's over-optimism.

"How about now, at $436? Is it worth as much as IBM? The market says it is, at least on the basis of simple equity capitalization. How can that be? IBM's earnings are more than Google's sales. We owned Google on the IPO and we own it now. We own IBM, too."

What's the secret to his success? Miller singles out three things. First, he buys both traditional value stocks, which he calls "cyclically mis-priced," and growth stocks, which he calls "secularly mis-priced." Owning a mix of growth and value stocks means that his fund is never totally out of sync with the market -- no matter which flavor is in vogue.

Reason number two: He buys more shares of the stocks he owns when their prices fall. "We average down relentlessly ... Someone once asked me how I knew when we were wrong to do that. When we can no longer get a quote, was my answer." I've long thought that Miller's confidence in the stocks he buys -- borne of painstaking analysis by him and his colleagues -- is the most important key to his success.

Reason number three: "Creative non action. We are mostly inert when it comes to shuffling the portfolio around, with turnover that has averaged in the 15% to 20% range, implying holding periods of more than 5 years. Many funds have turnover in excess of 100% 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."

Miller isn't afraid to admit his mistakes, even reminding shareholders of his investment in Enron.

"Sometimes we are right when we think the market is wrong, and sometimes we are not.... We were wrong to buy Enron when it was [involved in an accounting scandal]. Our analysis of Enron was excellent, in my opinion, despite our investment being unsuccessful. Process and outcome are two different things."

Yes, Miller is cocky. But when you're as good as he is, you can afford to be cocky.

Opinions expressed in this column are those of the author.