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| | Mutual Funds
A losing fund thats worth another look
The longtime manager of Legg Mason Value Trust is used to going against the crowd and profiting in the end. After three losing years, see why some still believe.
By Timothy Middleton
With Wall Streets poles reversed, and cheap, boring industrial stocks doing better than glamorous growth names, managers of most so-called value funds are riding high. Except for one.
He has lost an average of 6.4% of his shareholders money in each of the three years ended April 30. This year, hes down 13.8%, as of June 14. The longtime No. 1 performer in his group, he has fallen so far in the last 12 months that 97% of his rivals have done better.
The manager is Bill Miller, and the fund is Legg Mason Value Trust (LMVTX). In the roaring 1990s, Miller, who is also chief executive of Legg Mason Funds Management, became such an overwhelming presence that Morningstar.com dubbed him Fund Manager of the Decade.
And believers in Miller think his recent troubles are just proof of how farsighted he can be. Many mutual fund managers claim to be contrarians, but Bill Miller really does put his shareholders money where they almost certainly would be terrified to put it themselves.
His Top 10 list reads like a Most Wanted poster of corporate curs, such as Eastman Kodak (EK, news, msgs), Waste Management (WMI, news, msgs) and Tyco International (TYC, news, msgs).
Some of his stuff looks like outright mistakes, such as Tyco, which he bought in the first quarter, says Christopher Traulsen, the Morningstar analyst who has long followed the fund. But he says its awfully early to be calling them mistakes when Miller is famous for unpopular picks that subsequently turn popular again. Indeed, Tyco rallied 35% last week, though it was still trading 40% below its lowest price in the first quarter.
As the analyst on the fund, I certainly havent lost confidence in (Millers) ability, Traulsen says, noting that, bad as Miller did in 2000 and 2001, he still beat the market. Unless you think Miller has lost his marbles -- and Traulsen doesnt -- his funds fire-sale price could be an enticement, rather than a warning sign.
Value redefined
Miller has been manager of Value Trust since its inception 20 years ago. If you had put $10,000 with him at the beginning, youd have had $262,083 at the end of the first quarter.
But his reign has frequently been controversial, because his idea of value isnt shared by the kind of finance professors who set the tone in the mutual fund consulting world. They, and most traditional value managers, define a bargain as a low price-to-earnings multiple. Miller says hes found almost no correlation between a low P/E and subsequent higher profits, which are the fuel that drive stock prices upwards.
Ergo, despite its name, Value Trust is not a traditional value fund, and investors who own it to diversify a growth portfolio have blundered. It performs as if it were a growth fund, which is why it is foundering when value is soaring. Morningstar categorizes it as a large-cap blend fund, which is the category in which Vanguard 500 Index (VFINX) resides.
Miller defines value as share prices significantly below a companys intrinsic value. The backbone of his analytical tool set is discounted cash-flow analysis. According to Value Trusts first-quarter shareholder report, Miller finds a high correlation between growth in free cash flow and appreciation in stock prices.
(Legg Mason didnt return calls requesting an interview with Miller.)
The Legg Mason fund pays less than $10 for each $1 of cash flow it buys, according to Morningstar. The market average is twice that, and even the value group pays half again as much as Legg Mason, on average.
This approach can lead Miller to some pretty ugly names. He bought Enron late last year, thinking the market was overreacting to its problems. He quickly dumped the position, but it helped drag down returns.
Miller isnt timid in staking out his positions: The mammoth fund owns fewer than three dozen names, and the 10 largest account for nearly 50% of its $11.31 billion of assets.
| Legg Mason Value Trust Top 10 Holdings | | Stock | % of funds total assets* | | UnitedHealth Group (UNH, news, msgs) | 6.90% | | Waste Management (WMI, news, msgs) | 5.9 | | MGIC Investment Corp. (MTG, news, msgs) | 5.2 | | Albertsons (ABS, news, msgs) | 5 | | Washington Mutual (WM, news, msgs) | 4.5 | | Bank One (ONE, news, msgs) | 4.3 | | Amazon.com (AMZN, news, msgs) | 3.9 | | AES Corp. (AES, news, msgs) | 3.7 | | Tyco International (TYC, news, msgs) | 3.7 | | Eastman Kodak (EK, news, msgs) | 3.6 | | TOTAL | 46.8 |
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*Fund assets $11.31 billion as of 3/31/02.
Source: Legg Mason
Worth the risk?
That is a bushel basket of risk, and draws attention to the funds dark side. Risk shows up in the funds net asset value, which is 25% more volatile than the market itself, as measured by its five-year standard deviation of 25.98. By way of comparison, Janus Fund (JANSX) has a standard deviation of 27.05.
The Legg Mason funds other negative is that it is the worst kind of load fund -- the kind that charges an annual fee of 0.95% as long as you own the fund. This is by far the most expensive kind of fund to own. It takes the funds total expense ratio to an astronomical 1.69% -- more than twice the average of 0.78% for similar large, successful funds, according to the consulting firm Kanon Bloch Carr.
Said another way, 26% of the funds losses in each of the last three years were due to these rapacious expenses.
But Millers stellar long-term numbers -- 10-year annualized returns of 17.3%, more than 5 percentage points higher than the market -- come after expenses. If he continues to beat the market by such a wide margin in the future, expenses will be just a minor irritant.
Also, Millers low-turnover style -- the average holding period of a position is four years -- makes the fund more tax-efficient than 98.8% of domestic equity funds, according to Morningstar.
So for me, the Legg Mason fund is one of those hold your nose finds; despite its misleading name, high volatility and outrageous expenses, its actually a very good fund. And the cost of entry is about 20% less than it was three years ago.
At the time of publication, Timothy Middleton owned none of the securities mentioned in this article.
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