Big Number

The Law of Large Numbers: Bill Miller's Fall From Grace

Big Number

Bill Miller is widely considered one of the most successful investors of all time. At the helm of the Legg Mason Value Trust Fund (LMVTX) for over three decades, he earned the title of legendary by beating the S&P 500 for 15 consecutive years from 1991 through 2005. But all of that collapsed with the Great Recession.

This month, Legg Mason and Bill Miller decided to part ways after investors pulled nearly $779 million out of the fund given its recent significant short term underperformance. In the past year alone, Mr. Miller’s stock picks had left him in the bottom 2% of performers for managers in the same asset class while his fund earned $18 million in revenue for Legg Mason in 2015.[1]

So what happened?

It doesn’t seem reasonable to say that Bill lost his ability to understand companies, their financial statements, and the industries in which they operate. We are sure that his faculties are as sharp as ever.

It also doesn’t seem reasonable to believe that the market environment has changed so dramatically in the last decade as to completely change Bill’s ability to take advantage of the perceived “mispricings” that are taking place in the stock market. Competition was high back in 2004 and 2005 as it is today and while commissions and other trading costs have come down over the last decade, they aren’t so different to able to explain the significant underperformance of the fund over the last 5 years.

What does seem very reasonable to believe is that the law of large numbers finally caught up to Bill. In other words, the significant past performance displayed by Bill and his team might possibly come down to simple luck.  

This is not to say that Bill Miller is not intelligent or talented in his field. That is irrefutable because he obviously is. But how many intelligent and talented money managers are there in the fund management industry? Quite a bit, and competition for capital, information, and top returns automatically drives prices to fair value in a competitive market environment. In other words, it is extremely difficult to outsmart the smart consistently. As Chief Investment Officer at the Oxford Club, Alexander Green, astutely points out, “industry statistics show that three out of four mutual fund managers fail [to beat their benchmark] each year. More than 95% of them fail over a period of a decade or more.”[2] Yeah, it’s that difficult.

While highlighting the 15 consecutive years in which Bill Miller outperformed the market is impressive, widening the view beyond that specific 15-year period may paint a slightly different picture.  The alpha chart below shows the performance of the Legg Mason Value Trust (now known as the ClearBridge Value Fund) since inception versus its Morningstar assigned benchmark (Russell 1000 Index).

As you can see, there have been years where the fund has outperformed and years where it has underperformed, with the most recent 10-year period being one of the worst for the fund. In terms of overall “alpha” versus the benchmark, it has outperformed, on average, by 0.79% per year, but because there has been so much variation in the return of the fund, it is hard to say whether or not it is going to persist in the future. In fact, in order to be 95% sure, we would need 571 years of data. In other words, we would need more than half of a millennium of performance whether to figure out if this outperformance is in fact an act of skill…and then we would only be on 95% confident.

The downside of being wrong is that the actively managed mutual fund significantly underperforms the market, leaving investors in a possibly worst financial return than otherwise could have been earned by just sticking with a globally diversified portfolio of index funds. As we have mentioned in previous articles on stock picking managers, the odds are NOT stacked in the favor of fund shareholders.

Bill Miller was once the king of the active fund management industry. Although some may believe that he has lost his touch, we believe he has simply fallen victim to the law of large numbers. 

Lady Luck can be vicious!

[1] Kerber, Ross & Richard Leong. “RPT-Legg Mason’s Bill Miller Leaves Firm Amid Faded Glory.” Yahoo Finance. August 11, 2016.

[2] Green, Alexander. “Bill Miller…and the Problem With Your Actively Managed Funds.” The Oxford Club: Investment U. August 22, 2016.