For the second year in a row Bill Miller’s Legg Mason Value Trust mutual fund underperformed the S&P 500 Index (-6.7% return for the Value Trust vs. 5.49% for the S&P 500). These two years of underperformance come after a fifteen year run in which Value Trust outperformed the S&P 500. All this brings us to this question:
That’s the claim that Larry Swedroe makes in his latest newsletter.
For believers in active management the equivalent of finding the Holy Grail is identifying a manager who can persistently beat the market. The hero for many “believers” had been Bill Miller, legendary manager of the Legg Mason Value Trust (LMVTX). 2005 marked the fifteenth straight year his fund had beaten the S&P 500 Index—the longest streak on record. To the “faithful,” surely fifteen years had to be the result of skill and not random luck. That belief led to huge inflows of assets over the years. On the other hand, perhaps the streak was purely a lucky one. In 2006, the fund returned 5.9 percent, underperforming the S&P 500 Index by 9.9 percent. Perhaps that was just one bad year. Perhaps the market just did not see what Miller saw as real value. Unfortunately, the fund managed to repeat that dubious feat in 2007. The fund lost 6.7 percent, underperforming the S&P 500 Index by 12.2 percent. The last two years left the fund with a cumulative five-year record of underperforming the S&P 500 by 2 percent per annum.
Was Miller really skillful—and he had just lost his touch? Or, was he lucky and “Lady Luck” had abandoned him? And how is an investor to know which is the correct answer? And what should an investor in the fund do now? If you stay with the fund, how long do you wait before you give up? And if you sell, what if he turns the performance around—how would you know if it was skill or random luck showing up again?
The really bad news is that most of Miller’s great returns came when the fund was much smaller. The great returns attracted huge cash flows, and the longer the streak went on the greater the flows. The worst performance came when the fund had the most dollars. Thus, the returns actually earned by investors in the Legg Mason Value Trust are actually well below the returns reported by the fund. Of course, this is not the fault of the fund. Instead, the fault lies with investors who chose to ignore the evidence from academic studies that there is virtually no persistence of performance beyond the randomly expected (at least among winners—losers tend to repeat because of high expenses). And, as history suggests it would, the fund experienced large outflows in 2007. Investors withdraw almost $10 billion of assets in the fourth quarter of 2007 from the Legg Mason family of funds. Thus, even if Miller manages to once again outperform, many investors won’t be there to benefit.
Larry makes a good point. It is very difficult for a mutual fund to beat the benchmark. If they do, new money flows in which inevitably leads to underperformance. And, as the name implies Value Trust is a value fund. As this post shows, growth beat the snot out of value in 2007. That said, I do find it hard to believe that 15 years of beating the benchmark can be chalked up to luck.
What do you think?
Larry Swedroe is the author of Wise Investing Made Simple (2007), The Only Guide to a Winning Investment Strategy You’ll Ever Need (2005), What Wall Street Doesn’t Want You to Know (2000), Rational Investing in Irrational Times – How to Avoid the Costly Mistakes Even Smart People Make Today (2002), and The Successful Investor Today: 14 Simple Truths You Must Know When You Invest (2003), and co-author of The Only Guide to a Winning Bond Strategy You’ll Ever Need (2006) (All Affiliate Links). He is also a Principal and Director of both Research of Buckingham Asset Management and BAM Advisor Services — a Turnkey Asset Management Provider serving CPA-based Registered Investment Advisor (RIA) practices — in Clayton, Missouri (www.bamservices.com).
His opinions and comments expressed within this column are his own, and may not accurately reflect those of the firm.