The Rude Awakening
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Not-So-Sweet 16
Eric J. Fry Bill Miller's mutual fund has topped the returns of the S&P
500 Index for 15 straight years...But year sixteen might be
tricky. Miller's Legg Mason Value Trust (LMVTX) has the distinction
of being the only equity fund in the U.S. to beat the S&P
500 for the last 15 consecutive years. And over those 15
glorious years, the fund posted a cumulative return of
about 850% - more than double the return of the S&P 500
over the same time frame. To commemorate the feat, Barron's splashed Miller's mug and
his amazing track record on the cover of its January 9,
2006 issue. The glowing cover story was reason enough for
Miller's streak to end in 2006. A flattening yield curve,
and the fund's hefty allocation to Internet stocks, might
provide a second and third reason. We do not wish to disparage Miller's stock-picking acumen
when we suggest that he might suffer a bit of winning
streak interruptus in 2006. Rather, we wish to remind
ourselves that all good things come to an end
eventually...especially when those goods things rely upon a
portfolio of richly priced stocks. The average stock in the demonstrably above-average Value
Trust portfolio sells for 24 times earnings – that's about
40% pricier than the S&P 500. The capitalization-weighted
PE ratio would be even higher still, thanks to the
prominence of Internet stocks like Amazon.com in the
portfolio. Internet stocks comprise about 20% of Miller's
fund...but they have accounted for about 100% of his
lagging performance this year. As the table below details,
Miller's heavy allocation to Internet stocks has inflicted
a heavy cost.  Thanks largely to these big losers, Miller's fund trails
the S&P 500 Index by more than 6% year-to-date. But weep
not for Bill Miller; the man still has more than eight
months in which to work his magic. Furthermore, even if he
doesn't beat the S&P 500 this year, he'd still be hitting
15 for 16, which would be a respectable .937 batting
average.  No, we do not weep for Miller. But we do harbor a bit of
anxiety about the types of stocks that have fueled his
success. Now and then, high-flying growth stocks have a way
of becoming nose-diving losers, especially when short-term
interest rates are rising relative to long-term rates –
just as they are currently doing. 
We will not bore you with the reasons, theoretical or
actual, behind this relationship. Suffice to say that
capitalistic endeavors of various sorts tend to slow down
whenever the yield curve is inverting, especially if
interest rates are rising at the same time. These episodes
also tend to produce a depressive effect in the stock
market – i.e., high-flying growth stocks tend to
underperform other types of stocks. [Editor's note: An
"inverted" yield curve describes the condition when long-
term interest rates are lower than short-term interest
rates. Thus, if 2-year Treasury notes were yielding 5% and
the 10-year Treasuries were yielding 4%, the yield curve
would be inverted]. Luckily for Mr. Miller, the yield curve has inverted only
one time during his entire career at Value Trust. That year
was 2000. Miller's fund slumped 7.5% that year, slightly
better than the S&P's loss of 9.1%. In terms of Miller's relative performance, the early months
of 2006 bear a striking resemblance to 2000, and to most of
Miller's most challenging years. In six of Miller's 15
stellar years, he was trailing behind the S&P 500 as late
as April 27th (but never by as much as the 6% that he
currently trails). In five of the six, the yield curve was
flattening. The yield curve is flattening once again in
2006, and again, Value Trust is lagging. But let's not
place all the blame on the poor, defenseless yield curve.
Miller's brazenly large allocation to Internet stocks
deserves at least an honorable mention. The Value Trust's outsized stake in Internet stocks worked
wonders when these stocks were wonder-workers. But they
have become somewhat less wondrous of late, pulling the
Value Trust into the red for the year-to-date. This fact is
all the more discomforting when one realizes that the
Russell 2000 Index is up a whopping 15%. Throughout the
last several years, the Value Trust has tended to track
this "growthy" index quite closely. If, therefore, the
Russell were to begin taking a well-deserved rest at some
point soon, Miller's woes would likely intensify. To be blunt, in the today's hostile interest rate
environment, Miller's concept of "value" is not the sort
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