Bill Miller’s 15-year streak of beating the S&P 500 index is finally over. When the end came it was big. His fund, the US$ 21 billion Legg Mason Value Trust underperformed the market last year by a colossal 9.6 percentage points, coming in last of the 108 “multi-cap value” funds tracked by Bloomberg.
"Look after the long term and the short term should look after itself"
So what? After all, if the calendar year ended in any month other than December there would never have been such a long streak. What falls within the Gregorian calendar, or any calendar for that matter, is entirely arbitrary.
The insightful point about Mr. Miller streak is that he was not trying to outperform the market each and every calendar year. How could he be when his average holding period for a stock is 8 years?
Consistent short-term performance - one year is short term if you consider the time frame on which most companies invest in fixed assets employees etc - was not part of his long-term investment approach. In other words, look after the long term and the short term should look after itself.
If on the other hand you have a short-term approach and are actively trying to outperform on an annual or even quarterly basis you will fall short more often than not. This fact is borne out by the multitude of evidence that positively correlates good performance with low turnover.
It's a bit like golf. Consciously think about hitting the ball and you will probably hit a bad shot. Much better to think about swinging the club and let the ball contact be the consequence not the objective.
As Mr. Miller once said, “If you try to beat the index which is what most people do then you are thinking about what will do best over the next 12 months. That's the most efficient part of the market. Most businesses have a reasonably good idea of their prospects over the ensuing 12 months and their expectations are generally incorporated into stock prices. People who try to guess them are rolling dice.” And as we all know the house usually wins.
In fact, the logic behind Mr Miller’s consistent short-term performance is simple. He thinks on a time frame in which he has little competition and lets the market come to him. The chances are that in any 12 month period, the market will start to recognise in a number of Mr Miller's holdings what he had already seen, helping his fund’s performance. That's assuming of course that Mr Miller's long-term views were more right than wrong.
So how does one pick these long-term winners? The question is impossible to address here so I'm not going to try. What I will do however is refer to one of the great, albeit lesser-known stock pickers Philip Fisher and specifically to a particular question he used to ask companies - a question that so impressed former Forbes editor Jim Michaels that he composed an entire article around it. His question: what are you doing that your competitors aren't doing yet?
Think about it. What distinguishes truly great companies from the rest of the pack? The simple answer is innovation. But it's more complicated than that. Mr Fisher's question not only asked about the innovation itself but implicitly the extent to which it was a continuous process and whether it was a useful innovation which competitors would copy at some point.
As Mr Fisher, author of Common Stocks and Uncommon Profits said: “It's not what industry you're in, it's what you're doing right that your rivals haven't figured out yet.”
Arguably the greatest of Mr Fisher’s disciples is Warren Buffett. A few years back the Oracle of Omaha wrote, “It's been over 40 years since I integrated Phil's thinking into my investment philosophy. As a consequence, Berkshire Hathaway shareholders are far wealthier than they otherwise would have been.”
Mr Buffett's success is largely the result of skilfully combining Mr Fisher's philosophy with that of another investment heavyweight, Benjamin Graham. While Mr Fisher's approach was aimed at identifying companies with great growth prospects, Mr Graham - known as the Father of Value Investing - tore apart balance sheets to find companies that were trading below intrinsic value. As Mr Buffett said, “Value investing and growth investing are joined at the hip.”
Combining the two philosophies results in an approach that essentially aims to buy a dollar’s worth of assets for $0.50, where that dollar of assets will grow at a consistently above average rate. That is what Mr. Miller does and why he beats the market over the long term. As for that yearly streak ending it's a shame it has attracted so much publicity. What's worse however is how ingrained short-term judgement has become in the fund industry.
Indeed, the two leading fund rating agencies, Morningstar and Lipper failed to recognise Mr Miller's stellar long-term performance. Morningstar gives Value Trust a middle of the pack rating of three stars while Lipper penalises it with a below average score for poor preservation of capital, in both cases reflecting the emphasis on short-term volatility in ratings methodologies. The key to Mr. Miller’s success is his high concentration - his top ten holdings constitute 45% of the fund - but the above average volatility that this produces is the reason for investor caution according to the rating agencies.
In the grand scheme of things, the end of Mr. Miller’s streak is meaningless. After all a US$10,000 dollars investment in the Legg Mason Value Trust in 1991 would now be worth US$103,513 dollars – US$44,362 dollars more than an investment in the S&P 500 index - putting it in the top 5% of its peer group over the past decade. If that isn't preservation of capital at its best, I don't know what is!
Mr Miller’s thinking is that if a firm continues to grow rapidly it will become a bargain even if it doesn't seem like one today. Value Trust is still a bargain, it's just a little bruised that's all.
Published in the South China Morning Post
The views expressed in this communication are those of Peter Elston at the time of writing and are subject to change without notice. They do not constitute investment advice and whilst all reasonable efforts have been used to ensure the accuracy of the information contained in this communication, the reliability, completeness or accuracy of the content cannot be guaranteed. This communication provides information for professional use only and should not be relied upon by retail investors as the sole basis for investment.
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