Mutual Fund Talk

Is Bill Miller's Lucky Streak About To Be Over?

Morningstar's Greg Carlson concludes that although it will be hard for Bill Miller to pull off another last-minute trick to beat S&P 500 for the year, investor should be better off appreciating the long-term appeal of his Legg Mason Value (LMVTX) fund.

After beating the S&P 500 Index for a remarkable 15 consecutive years, Bill Miller of Legg Mason Value (LMVTX) is lagging the benchmark by nearly 11 percentage points for the year to date through Oct. 26, 2006. The extent to which the fund trails the S&P--which in turn has taken a toll on its longer-term comparisons with the benchmark--has some investors spooked. For example, after my colleague Russ Kinnel wrote a recent column that placed Miller among the 10 best current mutual fund managers, he received an e-mail from a reader who wrote that Miller, due to his bout of severe underperformance, is no longer among the industry's elite.

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The potential end of Miller's streak brings up a larger point. Even the very best managers tend to underperform, often for extended stretches. For example, two large-blend funds have outpaced or matched Legg Mason Value's return since the start of 1991 with the same lead manager at the helm: Longleaf Partners (LLPFX) and Vanguard Primecap (VPMCX). The former lagged the S&P 500 in seven of the past 15 calendar years, including five in a row in the late 1990s' bull market. And Vanguard Primecap trailed the index in five of those 15 years. The cause of this underperformance is clear. In order to beat the benchmark decisively, a manager has to be willing to build a portfolio that looks significantly different than the index and stick to his or her guns when that style is out of favor. (It's no coincidence that all three funds have had consistently low portfolio turnover.) The Longleaf fund typically owns just 20 stocks and will let cash build when appealing ideas are scarce, while the Primecap team tends to hold big stakes in its favorite sectors, particularly tech.

For his part, Miller certainly isn't shy about deviating from the benchmark. Of Legg Mason Value's 44 holdings, 36 are constituents of the S&P, but they comprise less than a fifth of that capitalization-weighted index. Five of the fund's top 10 holdings-- Sprint Nextel (S), utility concern AES (AES), telecom provider Qwest Communications International (Q), Sears Holdings (SHLD) , and Amazon--consume nearly a fourth of the fund's assets but less than 1% of the index. Furthermore, the fund has no holdings within the surging energy sector, a big reason why it merely squeaked by the index in 2004 and 2005. As a result of all these characteristics, the fund's returns are less correlated with those of the index than the vast majority of its category peers'.