Gustavo Ballvé on November 21st, 2011
Diversified financials, Food for thought, Home, Mental models, Portfolio Management, Risk management, Signal or Noise

Update (11/21, 8:16 ET): Fixed S&P 500 data for Bill Miller’s period as Value Trust manager.

Bill Miller himself once said: “This is a brutal business, success equals survival. If you have survived, you will have succeeded”. We have said it a little differently since 1988: to finish first, you must first finish.

Mr. Miller, famous for his 15-year streak of beating the S&P 500, has announced that he will step down as co-manager of the Legg Mason Value Trust in April 2012 (he will remain at the firm as Chairman). Investors of a certain age have certainly read a lot about this fund. Is Mr. Miller’s rise and subsequent fall a matter of genius becoming overconfidence or simple probability theory playing out as per Taleb? Not knowing the inside workings of Legg Mason Capital Management, no one can really claim to know the answer. To help us think about it, we collect several links inside.

The summary: Bill Miller took the reins of the Value Trust on April 16th 1982, and in the time since then he has “produced an annual return of 11.25%, according to Lipper“. The S&P 500 in the same period returned 8.3% p.a., not including dividend reinvestment. But in the 15-year period from 1991 to 2005 the fund beat the S&P 500 every year, which made the fund’s (and Bill Miller’s) fame global. Fortune Magazine called him “the greatest money manager of our time” in November 2006.

Well, ever since then it’s been downhill and the fund is now down a compounded 9.7% per year. The list of “mistakes” is all over the web, and it included Eastman Kodak, the mother of all case studies on cultural chains that bound a company to its past. As early as 2008 the press, so happy to boost him before, was calling for his head. Just remember that it’s always hard to call if it is a research, sizing, timing mistake or simply a matter of probabilities playing out unfavorably despite a good process.

Either way, even though the company did beat the S&P 500 over 15 years starting on Jan. 1st 1991, the returns are actually slightly lower than the S&P 500 from that same date until Bill Miller’s announcement on Nov. 16th (7.4% p.a. vs. 7.7% for the S&P).

Is this a case of people/ press deifying a man and a team because they were measuring “performance” as simply “outcomes” and forgetting about “processes”? In other words, was Bill Miller an “articulate coin flipper”? Here’s the odd part: Bill Miller and his company have always been concerned about investment as a multi-disciplinary, psychologically-driven, incentives-based field. He has studied widely and fostered innovative thinking in the industry – he has even hired Michael Mauboussin to be a “chief instigator” of sorts (official title: Chief Investment Strategist). Legg Mason, Mr. Miller, Mr. Mauboussin and others have been active members (Mr. Miller was Chairman of the Board and is Chairman Emeritus) and supporters of the Sante Fe Institute, a research powerhouse focused on “complexity research expanding the boundaries of science”. That doesn’t mean their processes were above questioning, nor that they couldn’t fall prey to some of the traps of success, but there’s at least the appearance that they had it covered at Legg Mason.

Overconfidence? Here’s an excerpt from Bill Miller’s letter to Value Trust shareholders in January of 2006, only days after completing the 15th straight year beating the S&P: “I thought it might be helpful, in addition to saying how much we appreciate your confidence in allowing us to invest your savings, to say a little about the principles…” (…) “You are probably aware that the Legg Mason Value Trust has outperformed the S&P 500 index for each of the past 15 calendar years. That may be the reason you decided to purchase the fund. If so, we are flattered, but believe you are setting yourself up for disappointment.” – Sure, it could be just lip service. But for over 12 years we have been reading his shareholder letters and he seems to really be the person who gave this interview to Money Magazine in 2007.

Could it be the old problem of size trumping performance? At its peak in 2007, Value Trust ballooned up to $27 billion in assets (when Mr. Miller resigned it was down to $2.8 billion). Again, not necessarily since there is evidence of long-term market outperformance with even larger assets (e.g. Berkshire Hathaway).

Mr. Miller has been rumored to be retiring and had been complaining about two things: “The huge rise of exchange-traded funds, which allowed people to buy baskets of things which caused correlations to rise, and of course the rise in algorithmic trading.” And this Financial Times LEX article on November 18th checks that out and says yes, correlation is going steadily up. But this is also certainly not enough.

Finally, it is worth noting that Mr. Miller is another one in a list of recent departures: George Soros and Stanley Druckenmiller have also recently quit. And in a big story in August of this year, the Financial Times noted that “several of the industry’s most prominent names have had a disastrous year so far.” That list in 2011 also includes John Paulson (the best of all active money managers in the five years that ended on December 31st, 2010) and Bruce Berkowitz of Fairholme.

There are no easy lessons here, no fingers to point. Remarkable, yet just another occasion to provoke thought, rekindle humility and remember once more that to finish first, first you must finish.

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