A Humbling Year for a Hedge-Fund Manager
Mutual-fund managers who beat the market for a time have a nasty habit of reverting to the mean.
I don’t risk my life by saving children from burning buildings or confronting hoodlums who are better armed than U.S. Marines. But I do have a tough job. As a hedge-fund manager, I’m either a bum or a hero, depending on how I’ve done during a given month or year. I’m graded constantly, and my clients care not one whit about my previous summa cum laude performance. They always ask me one question: “What have you done for me lately?”
Alas, for 2011 the answer was “Not much.” I had a subpar year—I lost money and I trailed the stock market—and now I’m scared. I fear that some of my clients will look at their year-end statements and think, This guy used to be so good. What happened?
Big-time slump. My trepidation has become more acute since I learned that Bill Miller will soon step down as manager of Legg Mason Value Trust (symbol LMVTX). Miller, after all, had compiled a fabulous record at Value, beating Standard & Poor’s 500-stock index each year from 1991 through 2005. But his performance since has been so awful that Value now trails the market over the past ten and 15 years and only nips it over 20. Over the past decade through 2011, Value has now underperformed the S&P 500 by an average of 3.5 percentage points per year. It’s as if Babe Ruth hit .342 with power for the first 15 years of his career and then became a singles hitter with a .225 batting average for the next five.
As a money manager with a good 16-year record, I can’t help but look at Miller’s career and think, There but for the grace of God go I. Unlike law or medicine, areas in which one’s relative merit tends to remain stable once it’s been established, money management can be cruelly fickle. There are two reasons. First, as studies have shown, mutual fund managers who beat the market for a time have a nasty habit of reverting to the mean—that is, underperforming—for the balance of their careers.
Second, even the best money managers and stewards of corporate cash (such as Warren Buffett, Prem Watsa of Fairfax Financial, and the Tisches at Loews) will often find their investment style grotesquely out of favor for years at a time. Back in 1999 and early 2000, people wondered if Warren Buffett had lost his marbles because he was lagging the bull market so badly. As it turned out, the misplaced marbles belonged not to Buffett but to the tech-addled investors who drove prices up to—and beyond—ludicrous levels. Between March 10, 2000, and December 31, 2011, the tech-heavy Nasdaq Composite index fell 48.4%, while shares of Berkshire Hathaway, the company Buffett heads, advanced 177.9%.
When a manager is doing badly, he doesn’t know when, or if, he’ll ever be vindicated. For many of us, it can be a supremely awful feeling. During such stretches, three thoughts tend to occur to me. The fatalistic: “This is the business we’ve chosen,” as Hyman Roth told Michael Corleone. The useless: Steer in the direction of the skid. And the optimistic: Well, it’s cocktail hour somewhere.
But as a manager whose first 12 years were better than his last four, I sometimes wonder if the mean-reversion monster will come and get me. I’m reminded of a fund manager I once interviewed for Kiplinger’s. He delivered sterling results in his first five years, but over the next 15 he stunk up the joint. Yet, in his mind, those first five years defined his ability; the next 15 were an aberration. If I stay at this long enough, might I someday wind up both subpar and delusional?
And even I, a long-term value investor, find it hard to forgive someone a bad decade. When I heard Bill Miller speak at a conference three years ago, he gave excellent reasons for investing in Freddie Mac. But not for a second did I think about buying the stock. I had come to regard an endorsement from Miller as a kiss of death. After all, he hadn’t done anything for me lately.