Bill Miller and Value Trust

March 22, 2018 Philosophy

? Bill Miller and Value Trust Background Information Bill Miller is one of the most renowned professional fund managers. This can be proven by the outperformance of the Value Trust, which is managed by him, compared to its benchmark index, the Standard & Poor’s 500 Index (S&P 500), for an astonishing 14 years in a row; and this marked the longest streak of success for any manager in the mutual-fund industry. By the middle of 2005, Value Trust is worth $11. 2-billion. Bill Miller’s approach to investment management was research-intensive and highly concentrated.

For instance, nearly 50 percent of Value Trust’s assets were invested in just 10 large-capitalization companies. While most of Bill Miller’s investments were value stocks, he was not averse to taking large positions in the stocks of growth companies. In other words, Bill Miller’s investing style is iconoclastic: “You simply can’t do what he’s done in the supremely competitive, ultra-efficient world of stock picking by following the pack…The fact is that Miller has spent decades studying freethinking overachievers, and along the way he’s become one himself. ” Mutual Funds Definition

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A mutual fund is an investment vehicle that pooled the funds of individual investors to buy a portfolio of securities, stocks, bonds, and money-market instruments to meet specific investment objectives; investors owned a pro rata share of the overall investment portfolio (Bruner, 2007). The various investments included in a fund’s portfolio are handled by professional money managers in line with the stated investment policy of the fund. All mutual funds have a portfolio manager, or investment advisor, who directs the fund’s investments according to explicit investment objectives.

Mutual Fund Types Investors have different objectives, so various types of mutual funds are needed to help them achieve their goals. Most mutual funds fit into one of three basic categories: money market mutual funds, bond funds, and stock funds. Money market mutual funds hold cash reserves, or short-term debt investments issued by the government, corporations, or financial institutions (i. e. , U. S. Treasury bills and bank certificates of deposit). Bond funds invest in debt instruments issued by corporations or government agencies.

Stock funds are one of the most popular types of mutual funds, ranging from relatively conservative equity income funds to value funds, growth funds, aggressive growth funds, small-company funds, and international funds (Hirschey and Nofsinger, 2008). Advantages of Mutual Funds Diversification Using mutual funds can help an investor diversify their portfolio with a minimum investment. When investing in a single mutual fund, an investor is actually investing in numerous securities and spreading investment across a range of securities can help to reduce risk but will never completely eliminate it.

If a few securities in the mutual fund lose value or become worthless, the loss maybe offset by other securities that appreciate in value. Professional Management Mutual funds are managed and supervised by investment professionals. As per the stated objectives set forth in the prospectus, along with prevailing market conditions and other factors, the mutual fund manager will decide when to buy or sell securities. This eliminates the investor of the difficult task of trying to time the market.

Furthermore, mutual funds can eliminate the cost an investor would incur when proper due diligence is given to researching securities. Convenience With most mutual funds, buying and selling shares, changing distribution options, and obtaining information can be accomplished conveniently by telephone, by mail, or online. Minimum Initial Investment Most mutual funds have a minimum initial purchase of $2,500 but some are as low as $1,000. Disadvantages of Mutual Funds Risks and Costs Changing market conditions can create fluctuations in the value of a mutual fund investment.

There are fees and expenses associated with investing in mutual funds that do not usually occur when purchasing individual securities directly. There are drawbacks associated with mutual funds: No Guarantees. The value of mutual fund investment could fall and be worth less than the principle initially invested. The Diversification “Penalty”. Diversification can help to reduce your risk of loss from holding a single security, but it limits your potential for a “home run” if a single security increases dramatically in value. Costs.

In some cases, the efficiencies of fund ownership are offset by a combination of sales commissions, redemption fees, and operating expenses. If the fund is purchased in a taxable account, taxes may have to be paid on capital gains. Expenses Because mutual funds are professionally managed investments, there are management fees and operating expenses associated with investing in a fund, which is called expense ratios ranging from 0. 2% to 2. 0%. These fees and expenses charged by the fund are passed onto shareholders and deducted from the fund’s return. Taxes

As a fund shareholder, you can be taxed on distributions of dividends and/or capital gains made by the fund and profits you make when you sell the fund shares. Research Hypothesis 1. There is a possibility that his overall performance may be affected because of Bill Miller’s choice of concentrating heavily in certain sectors such as financials, health, consumer goods, and telecommunications. 2. By examining and analyzing various theoretical explanations, we will be able to determine whether Bill Miller’s success is dependent on luck and/or skill and whether it is sustainable or not.

Evaluation of Bill Miller’s Performance Bill Miller’s results seemed to contradict conventional theories, which suggested that, in markets characterized by high competition, easy entry, and information efficiency, it would be extremely difficult to beat the market on sustained basis. Efficient Market Hypothesis (EMH) There are three levels of market efficiency which were distinguished by the degree of information believed to be reflected in current securities’ prices. The weak form of efficiency maintained that all past prices for a tock were impounded into today’s price. The semistrong form of efficiency held that today’s prices reflected not only all past prices, but also all publicly available information. The strong form of efficiency held that today’s stock price reflected all the information that could be acquired through a close analysis of the company and the economy. Many scholars argued that the sock market followed a “random walk”, where the price movements of tomorrow were essentially uncorrelated with the price movements of today.

They argued that capital markets’ information was efficient, and that the insights available to any one fundamental analyst were bound to be impounded quickly into share prices. If EMH were correct and all current prices reflected the true value of the underlying securities, then arguably it would be impossible to beat the market with superior skill or intellect. “In such a market,” as one economist said, “We would observe lucky and unlucky investors, but we wouldn’t find any superior investment managers who can consistently beat the market. Yet, Bill Miller, who over long periods, greatly outperformed the market. In reply, Malkiel suggested that beating the market was much like participating in a coin-tossing contest where those who consistently flip heads are the winners. Malkiel suggested that the success of a few superstar portfolio managers could be explained as luck. Similarly, the stock-market crash on October 1987 had also seemed to undermine the strength of the EMH. Academic research exposed other inconsistencies with the EMH, for example, January effect, blue Monday effect, etc.

Those results were inconsistent with a random walk of prices and returns. Bill Miller was an adherent of fundamental analysis; his approach was research-intensive and highly concentrated. Nearly 50% of Value Trust’s asserts were invested in just 10 large-capitalization companies. Analysis of Bill Miller’s Key Strategies Bill Miller, portfolio manager for Legg Mason Value Trust, had a great track record for an astonishing fourteen years in a row.

He was the only active mutual fund manager to have consistently beaten the S&P 500 over the last fourteen years. Bill Miller pointed out that his streak was due to luck; 95 percent luck. This section will evaluate Bill Miller’s investment philosophies and whether he is just plain lucky or it is based on luck and sustainability. The figure below lists the categories in which Bill Miller has invested in and the annual returns each category receives: As can be seen in the figure above, Value Trust has a portfolio that is highly volatile.

Although highly volatile, the concentrated portfolio still showed outperformance when judged by calendar years, thus giving an ominous sign that the outperformance is not the result of good stock picking, but merely the result of taking on greater risk than the market as a whole. Bill Miller’s investment philosophy to build up Value Trust is to consistently buy cheap stocks, and focused on established companies suffering through periods of poor performance. These judgments resulted in Value Trust’s outperformance for fourteen years. However, taking risks (i. . having a highly concentrated volatile portfolio) and underperforming the value style (i. e. buying cheap stocks from companies suffering through periods of poor performance) is not a good combination and could hurt him later on. One might think that Bill Miller’s investment philosophy could be a “value trap”, mistaking a more or less permanent change in value or industry conditions for a temporary one. The bulk of Bill Miller’s portfolio is from consumer (i. e. homebuilding) and financial categories. These stocks tend to trade at cheap prices.

Furthermore, the housing bubble began inflating in mid 1990’s, thus making it an easy way for investors like Bill Miller to make money. This event led to further success of Value Trust despite the high level of volatility. Investment Philosophies Buy low-price, high intrinsic-value stocks Bill Miller tends to invest in stocks that are undervalued by the market. People believe that a business is broken, scandal, but the company is still able to generate positive future cash flows. He buys low and sell high. The market price in long run still imitates the value of the firm. Take heart in pessimistic markets

Bill Miller tends to invest in stocks that have the least promising outlook and sell those stocks that have the greatest opportunity for near-term gain. In other words, Bill Miller is investing in stocks that have the greatest opportunity for long-term gain instead of near-term gain. Remember that the lowest average cost wins The lower the shares go, the higher the future rate of return and the more money you should invest in them. When a stock drops and he believes in the fundamentals, the case for future retunes goes up. Again, market price in long run still imitates the value of the firm.

Buy low-expectation stocks When the market’s been down for a while, and it looks bad, then you should be more aggressive, and when it’s been up for a while, then you should be less aggressive. Bill Miller thinks buying low-expectation stocks, buying higher dividend-yielding stocks, staying away from things with high expense ratios. Take the long view Bill Miller tends to hold onto stocks he invested in for a long period of time which results in a low portfolio turnover. According to him, the biggest opportunity for investors is really thinking out longer term.

Look for cyclical and secular underpricing Bill Miller tends to invest in stocks that are undervalued or mispriced. He believes that most growth people own stocks that are secularly underpriced; things that can grow for long periods of time. Behavioural Finance Bill Miller’s educational background in Philosophy and Economics and his active involvement in the study of Behavioural Finance reflect his investment strategy. During Bill Miller’s Investment Conference in 2004, he remarked that “I believe that every exploitable anomaly in the market is behaviourally based.

This is the only way that sustainable anomalies can be created. These are the anomalies that are not easily arbitraged away. One of the most remarkable behavioural anomalies that we see is that people take today’s data (e. g. , the GDP report, the unemployment report) and concludes that the market is getting ahead of itself. The market does not look at today’s data. It is looking at the data down the road. ” This statement demonstrates that his belief that the market reflects the available information fairly accurately in the short term.

In addition, he remarked that “Because the market looks forward, because the market discounts, and because the market prices reflect, in essence, the data refracted through the decision procedures and emotions of investors, then the market will change as the world changes because it is incorporating new information. ” With this statement, it appears that Bill Miller expresses a partial belief in the EMH, unlike Warren Buffet. Value Investing As what was stated in the case, Bill Miller has been following an approach to equity investing and followed a number of strategies, specifically Ben Graham’s.

Bill Miller analyzes and evaluates the stocks performance in the long run which explains his strategy of buying low, with high intrinsic value. In addition, he has been holding onto stocks for a longer period than an average fund manager, hence a low turn-over rate which explains his strategy of taking the long view. Conclusion By comparing Miller’s investment philosophy with Warren Buffett’s, there is one thing that makes Buffett’s investment philosophy more applicable and Miller’s philosophy a “swing-for-the-fences” approach.

Miller should look at a company’s financials before making an investment. His view of welcoming negative sentiment about companies and buying stocks as their prices fall failed to look at the company’s liquidity. The company could have issues with high levels of debt and poor financials. Even though if for instance, some of his stocks (due to volatility) have failed to meet his expectations (a “stinker”), the inflated housing bubble that grew during the 1990s caused high levels of annual return could still make the overall performance of Value Trust successful compared to the others.

Thus, given the nature of his concentrated portfolio, his long outperformance can be seen as a random variable, or “luck”. There are approximately 8,044 mutual funds out there; and 4,600 of these were U. S. equity mutual funds. Thus, there is a 50 percent chance of beating the market. Since Bill Miller has outperformed its competitors over fourteen consecutive years, how come no one has followed in his footsteps?

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