Bill Miller on Commodities and Market Physics

Here’s a really old article, flagged it a long time ago, and just got to it now: “Bill Miller on Commodities.” How true is that? To make some money by buying things at the right place and the right time (if that is your fancy) you have to be buying things that are in the dumps, things that no one has made money on in a really long time, things that are cheap. It is funny how most humans never figure this out. Part of the reason why this happens is that bull markets can be so prolonged. The other reason I think is that when the big crashes hit, no one has any spare cash around to invest in the cheap stuff because, well, it was all invested, and now you’ve lost it.

One final reason could be that humans seem to have Newton’s 1st law of motion hard-wired into their brains. The law says that an object will not change velocity until a force acts upon it. Humans have a slightly corrupted version of this law programmed in their brains, however. A version that ignores the “until a force acts upon it” part. People forget so easily that there are forces that can cause markets to “change velocity” from upwards to downwards, instead thinking that the velocity will stay upwards (as if the world was frictionless). Inflation, rising interest rates, commodity shortages, natural disasters, a huge shift from the historical mean, war, stupidity, corruption, routine market correction, etc… In fact, in another analogy with physics, you could probably say that the magnitude of the restoring force involved is proportional to how far away from the mean the market has travelled, just like a spring (see Hooke’s Law). In other words, the bigger they are the harder they fall.

I’m curious, what has done really badly in the past few years anyways? What has performed the worst? I did a quick check of index funds using‘s fund filter and sorted them by worst performers over the past 3 years. It looks like tech stocks/nasdaq, bonds, and US equities (due to US dollar decline) have been the worst performers in increasing order of better performance. We also can’t forget about cash which also hasn’t performed too well (in never does, but it doesn’t do that badly either, just losing a few percent every year due to inflation). 🙂 What has performed the best over the past 3 years? Well just about everything, energy stocks, gold, Canadian equities, REITs, international equities, European equities, in decreasing order of performance. Anyways, don’t read too much into that, it’s just me playing around. I have a hunch though, that those investments that have performed well over the past 3 years are probably less likely to perform as well going forward.

Aside: Newton himself famously lost 20,000 pounds (in 1720, worth 1.9 million pounds in today’s dollars) on the South Seas bubble.

Has Miller’s fund outgrown his touch?

Has Miller’s fund outgrown his touch? discusses whether or not Bill Miller can continue to beat the S&P 500 for much longer. Bill Miller is investment manager for Legg Mason Value Trust. I recently purchased shares in CI Value Trust (Value Trust’s Canadian dollar equivalent) and currently it makes up my entire US portfolio.

. . . don’t be surprised if the fund hits head winds. It barely beat the S&P 500 last year, nosing it by less than a percentage point. And Value Trust trailed the S&P 500 for the first quarter, falling slightly while the index gained 4 percent.

Miller himself notes that the 15-year beating-the-S&P record is just “a fortunate accident of the calendar,”:

he added, noting that there would be no 15-year streak if the investment year ended in any month but December; in some years, Value Trust trailed the index in the 12 months ending in January, February and so forth.

The author Jay Hancok argues (briefly) that it would benefit current investors if the fund was closed up to new investors:

Is it time to close Legg Mason’s flagship mutual fund, Value Trust, to new investors? A good argument can be made that the answer, at least for current investors, is yes.

But Legg Mason has no plans of closing it up just yet:

Its money-management team “believes the fund can comfortably manage substantially greater assets than those presently under management,” says Miller in his statement to me. Value Trust’s low turnover will help.

Miller himself pointed out that:

many successful “managed” (non-index) funds are bigger. Fidelity Investments’ Contrafund had $65 billion in assets last month when it announced that it would bar new investors, to focus on working for existing shareholders.

The author argues that “the more S&P 500 stock that Value Trust absorbs, the harder it’s going to be for Value Trust to outperform the S&P 500.” This is less of a problem for Bill Miller, however, who “makes big, bold bets on relatively few stocks. At the end of last year – the most recent information available – just 10 stocks made up 45 percent of Value Trust’s holdings.”

Too Many Choices (or why I am ready to give up)

If you have read my last post you will know by now that I am set to start my new portfolio at Clearsight. I have been debating what to choose for my US equity component, and whether or not to go with my advisor’s recommendation of CI Value Trust (satellite fund of Legg Mason Value Trust). I said in my last post that am not interested in investing in Bill Miller‘s Value Trust fund but that I said I would rather go with the Rydex S&P 500 Equal Weight Index ETF (RSP) instead. I have now come to the realization that RSP is very similar to the S&P 400 Midcap Index which is also available as an ETF (MDY). It is very highly correlated and comparing the performance of these two ETFs makes this obvious. There is also a small advantage to getting MDY over RSP in that “the higher volume on MDY is an advantage for that fund, as is the typically tighter bid/ask spread” but this is probably splitting hairs. Comparing either of these two funds to Bill Miller’s Value Trust is probably not a fair comparison, just as comparing S&P 500 (huge-cap) to S&P 500 Equal Weight (semi-large to large-cap) is not exactly a fair comparison as they are in different classes and will of course perform differently. I found yet another index choice today, the S&P 500 Value Index (IVE). It has beaten the S&P 500 index but it has not been able to catch Bill Miller’s Value Trust. Sounds like a great alternative to the S&P 500 index though as it screens out some stocks which aren’t a good value.

At this point I began to get frustrated with the number of choices out there. RSP, SPY, MDY, IVE, and that is only a few of the ETFs available. Then there are the actively managed mutual funds, LMVTX being only one of many, and of course there are the index mutual funds of which there are probably one for every index just like the ETFs I mentioned above. Sometimes I feel like I know exactly what I want, other times I can not makes heads or tails of it with all the choices and knowing there are even more choices out there that I have not examined is daunting. It is frustrating for some someone like me, skilled in the maths and sciences and now software, that there is not some exact deterministic way of determining the ideal choice.

When I left TD, one of the main reasons was because I did not have a proper selection process for what I would buy for my RRSPs. Usually I would scan the performance (usually the longest term possible, 10-years or since inception if available) and choose funds that looked like they had done well in the past. This was flawed because crappy funds can have a few stellar years and good funds can have a few bad years. Or sometimes I would look for funds that did well in the past, but might have just come off a bad year (hoping to catch the fund on the up-swing). This method was also flawed. The second reason I left TD was that I did not want to be a DIYer anymore. I felt like an amateur/hack trying to do a professional’s job, and I was not succeeding. Not only that but I did not have enough time to spend on this. You may think that writing and researching articles for this blog takes time, and yes is does (and I have learned a lot about investing by writing this blog), but it cannot compare to the amount of time financial advisors and their superiors have spent day in and day out trying to answer these same questions. It is after all their full-time job. My financial advisor says that he does not pick stocks. He leaves that to the professionals, such as Ross Healy or Bill Miller. He does not have time to research stocks for his clients. By the same token, I should leave the management of my portfolio to my advisor because I do not have time to do it myself.

This does not mean that I should leave everything up to my advisor. Much like my advisor will monitor the actions of Ross Healy and Bill Miller I should also vet all actions my advisor recommends for my portfolio. Right now I think I am ready to give up and let him decide what is best. I would like to have a say in the asset allocation and I really want to have 25% bonds and the rest balanced between Canadian, US, and International. But as for what is inside those categories I really do not have the time to examine his choices of holdings for me in microscopic detail. It has already taken far too much of my time. The portfolio that my advisor is recommending is already much better than my old TD portfolio for many reasons, and if going with an advisor helps keep my hands off my portfolio and helps me keep this allocation over the long term, then it will surely achieve much better performance in the long run than I was getting with TD as a DIYer.

No time to read over this rant, it’s too long. Grammar mistakes be damned!

Beating Bill Miller

Ever since my advisor recommended Bill Miller’s Value Trust fund I’ve been following him closely. An article, “Beating Bill Miller” caught my eye. The article raises the interesting point, that while he has beaten the S&P 500 every year for the past 15 years, there are other funds that, while maybe losing to the S&P500 in any given year, have beaten his fund over the same time period:

We congratulate Miller on his fine performance, but we’d be remiss if we did not point out that while he has indeed outperformed the S&P 500 Index since the first Gulf War, there are funds (22 of them, in fact) that have outperformed Legg Mason Value Trust over the same time period, according to Morningstar.

Even though these funds may not have beaten the benchmark in each and every year, they have produced returns higher than the 16.44% annualized posted by Miller over the same time period (net of fees and reflecting reinvestment of all distributions).

Miller himself tries to play-down the emphasis on beating the market on a yearly basis and tries to remind investors to think longer term:

In a letter this week to shareholders, Miller said that investors buying into LMVTX because of its 15-year run of benchmark-beating may be setting themselves up for disappointment. “Our goal is to construct portfolios that have the potential to outperform the market over an investment time horizon of three to five years without assuming undue risk,” writes Miller. “If we achieve that goal, we believe we will be doing our job, whether we beat the market each and every year or not.”

In the next couple articles I’ll go over a few of the article’s suggestions for other value-oriented funds which have beaten the S&P500 and Bill Miller’s Value Trust in the past.

Bill Miller Beats S&P 500 for 15th Consecutive Year

This is somewhat old news, but still newsworthy: Bill Miller’s Legg Mason Value Trust Fund has beaten the S&P500 for the 15th consecutive year. Canadian investors can invest in this fund through the CI Value Trust fund.

It is interesting that in the past two and a half years, he hasn’t been able to beat the S&P 500 Equal-Weight Index (^SPXEW) (as tracked by the Rydex Equal-Weight S&P 500 ETF (RSP)). This plot goes back a bit further. You can see that Legg Mason Value Trust has only beaten the S&P 500 Equal-Weight Index (^SPXEW) in the last 6 months. In 2005, 2004, and the portion of 2003 (the index’s year of inception), ^SPXEW has beaten Bill Miller’s Fund.

Bill Miller’s Winning Streak

With just over a week to go in 2005, Bill Miller’s Value Trust fund looks set to beat the S&P for the 15th consecutive year.

Certainly, Mr. Miller’s 14-year winning streak is impressive, especially in the context of professional fund management, an industry in which the average fund manager typically underperforms broad market indices like the S&P 500. Mutual fund screeners (e.g., Yahoo’s, which takes data from Morningstar) show about 11,000 stock funds. Noting that 11,000 sits between 2-to-the-13th power (8,182) and 2-to-the-14th power (16,384), we should expect by pure probability alone to find about one fund manager in 11,000 who has a winning streak of 13 or 14 years (similar to performing 11,000 trials of 13 or 14 coin tosses and finding one streak of all heads). From this perspective, Mr. Miller’s performance is still exceptional (just as a string of all heads is exceptional), but we should not be surprised to find an exceptional performer among the many thousands of mutual fund managers out there. In other words, while Mr. Miller does appear to have a “golden touch,” he is not necessarily a living incarnation of King Midas.

Google shares reach $400, still a good value?

Today, Google’s shares reached $400. It seems unlikely that any true value investor would consider Google (GOOG) to be a good “value.” Renowned fund manager Bill Miller seem to think it is. His Value Trust fund (a fund that I am considered for my US portfolio) has a good portion (4.3%) of it’s assets invested in Google. Bill Miller “follows a value discipline in selecting securities” according to Value Trust fund’s Investment Strategies statement.

Just for fun, I wanted to see if Google meets any of Graham’s basic criteria for defensive investors (or rather, how badly it fails):

  • Google’s price/book ratio from the most-recent quarter is 12.64. Graham probably wouldn’t touch Google unless it’s P/B Ratio was less than 1.5, meaning Google would have to trade in the $50 range.
  • Google does have a positive book value, which Graham considered a must.
  • Google’s current ratio from the most recent quarter is 15. Graham looked for a current ratio of at least 2.
  • Google’s growth rate has been phenomenal. About 400% from 2003 to 2004, and on pace to grow earnings about 350-400% in 2005. Graham looked for earnings growth of 33% over 10 years. Google hasn’t even been around for 10 years yet and Graham would probably classify it as a “new issue” and would stay clear of it.
  • Google has never paid a dividend. Graham looked for stocks with uninterrupted dividends over 20 years.
  • Google has not made money in each of the last 10 years. Graham liked businesses which had some earnings in each of the past 10 years. Since Google was a start-up not too long ago, there was a time within the last 10 years when it did not make money. Basically Google fails this test because it is just too new.
  • Google’s revenue was $3 billion in 2004, on pace for more than that in 2005. Graham recommends investments with annual revenue of more than $500 million (in today’s dollars).
  • GOOG’s valuation is now $119 billion. This meets Graham’s criteria of being a large-cap stock. Although if Google were valued at its book value of $9 billion it doesn’t look so big.
  • P/E ratio on trailing 12-month earnings is about 89. This is well above Graham’s recommended 15.

Google fails several of these basic criteria by such a huge margin that it makes me feel good about not owning Google, and somewhat worried about buying Bill Miller’s Fund. Apparently, in retrospect, Google’s IPO price of around $100 was a good value, and so was $200 3 months later. And it was still a good value earlier this year when it traded at $300. Google has certainly paid off for Bill Miller who apparently bought it at $85. I’m just not sure if he’s skilled or lucky. Some of his other tech stocks have not fared as well, such as Amazon and eBay, both among his top 10 holdings, and he is at risk of ending his 15 year beat-the-S&P500 streak. Miller’s Value Trust fund has only gained 1.82% this year so far, compared to 3.06% for the S&P 500.

Out of curiosity, I checked ABC Funds American Value Fund, a true value fund (no tech stocks here), and is up 6.34% year-to-date as of October 31, 2005. I am a bit more comfortable with ABC Funds’ true value investing approach, but the minimum required investment is just too high for me right now.