I was shocked to see the front page of Barron’s with the image of investing legend Bill Miller titled “He’s Back! – It’s Miller Time”. The article says Miller is back at the top of his game after a disastrous 2 year run. A closer look at Miller’s fund and the mutual fund industry actually shows a pervasive and destructive problem on Wall Street - a total and complete lack of risk management.
The Barrons interview claims that Miller’s fund is worth taking a look at again. Miller himself even says that his patient investors have been rewarded:
“The shareholders who stuck with us believed in our process and have seen us underperform; it has happened before,” Miller told Barron’s in a recent interview. At least “we built up large tax-loss carry forwards, which will mean no capital-gains taxes, which may go up.”
In 2007 Miller lost 6.7% and then lost an astounding 55% in 2008. His fund is up over 36% this year. $100,000 invested with Miller over the last two years would leave you with roughly $60,000 today. Glad you stuck with Miller? Miller goes on to claim that his performance this year is due to superb risk management:
But this time was different. “This turned out to be a collateral-driven crisis caused by underperforming debt,” also known as toxic assets, Miller says. “We’ve analyzed that mistake and tried to make adjustments to risk management and the portfolio-construction process.”
Risk management? Hardly. Read on….Bill Miller is infamous for supposedly outperforming the S&P 500 for 15 straight years. He has made hundreds of millions of dollars due to this performance and essentially built the Legg Mason brand by himself. But a look under the hood shows a massive Wall Street problem. See, Miller is a part of an industry that has been proven to underperform a standard index fund (more than a handful of studies show that over 80% of all mutual funds underperform a comparable apples to apples index).
What mutual funds like Miller’s do is this: they come up with fancy sounding names that give investors the impression they are investing in one thing when in fact they are investing in an index fund clone – meanwhile, they charge you 1-2% more than the index and more often than not, they underperform that index. Miller’s Legg Mason “Value Trust” is a great example. You hear “Value Trust” and you think “ahh, value investing – isn’t that the super safe strategy that Warren Buffett uses?” Well, not exactly. Miller’s fund, like many funds, isn’t exactly a value fund. In fact, at times it is highly aggressive and more comparable to a growth fund. Many of his largest holdings are classic high beta names – Google, Ebay, etc.
Let’s dig a little deeper. What investors don’t account for is risk adjusted returns. You hear “Value Trust” or “Large Cap Blend” and you think it’s safe to do an apples to apples comparison with the S&P 500, right? Wrong. Miller’s fund actually has atrocious risk adjusted returns. His fund has returned 6.8% since inception which is actually slightly worse than the 8% return of the S&P 500 during the same period. To be fair, let’s cherry pick the years and see what we get.
I ran a regression on the last 17 years of performance (in order to include many of Miller’s best performing years in an attempt to overweight the positive results). The results speak for themselves. In a period where the S&P 500 averaged a standard deviation of 21 Miller’s fund averaged 27.5. His 8.4% return during this period sounds remarkable compared to the S&P’s 5.5% return, but the end result of a Sharpe ratio of 0.34 is actually less than impressive. In fact, it proves that Miller is adding little to no value for his investors after you account for risk. I also obtained results using slightly more aggressive future return assumptions. The conclusions are the same. (I should also add that I chose to run a Sharpe ratio over a Sortino ratio because Miller’s fund over the period had a fairly balanced level of positive and negative volatility.)
I don’t mean to pick on Miller, but he represents a much larger problem with the current investment world. The Barron’s article is highly misleading and makes the same mistake that most investors make when picking a fund – they don’t actually look under the hood. They just drive the car off the lot and assume that because the MPG and price looked good then the engine must be better than most.
Funds like these are almost always a poor choice over a standard index fund. There are only a handful of funds that actually exercise true risk management and have proven that their performance is better than flipping coins. The problem with this business is that there are more than $26 trillion invested in mutual funds. This means a staggering amount of assets are held hostage to higher fees and poor performance. Many of these assets are in retirement plans where unwitting investors have no choice but to invest in a high fee perennial group of underachievers. Why hasn’t the business evolved beyond this after so many reports have proven that the mutual fund business underperforms?
The financial crisis has unearthed some serious problems with Wall Street and this one shouldn’t be overlooked. The big fund companies are no different than the big banks. They are in the pockets of the insiders, the government and the corporations. As a result the loser is the taxpayer and the little guy. Investors have options in today’s evolving investment world and they deserve to have their hands untied and the gun removed from their temples. Why does this industry continue to wield so much power over the investment world? Investors deserve better.
Sources: Barrons, Morningstar