The greatest money manager of our time
What do ant colonies, novels and river systems have to do with making money? Ask Bill Miller, the man who's topped the market 15 years running. Fortune managing editor Andy Serwer reports.
(Fortune Magazine) -- Have you heard the story about the money managers and the three bears? It was a gorgeous afternoon last June on a ranch outside Cody, Wyo. Legendary investor Bill Miller was riding horseback with Chris Davis of Davis Funds and Michael Larson, who runs Cascade, Bill Gates' investment company.
The three had been out about an hour when dead ahead of them, no more than 100 yards off, appeared three grizzly bears. Larson gently pulled up on his reins and quietly began to back his horse away. But Miller had other ideas. "Let's see how close we can get," he said, and edged ahead. Larson stayed back. "I don't know what Bill was thinking," Larson said later. "I guess he figures he's on a horse and can ride faster than Chris Davis."
Larson, Miller and Davis escaped. And Miller had no intention of turning his friend into bear bait. What Miller was doing out there in the wilds of Wyoming was pretty close to what he does every day in his office overlooking the inner harbor of Baltimore: taking extraordinary, calculated risks, ones that most people - whether nature lovers or investors - would find unimaginable. The thing about Miller is that more often than not, he turns out to be right.
In case you haven't heard of him, Bill Miller is one of the greatest investors of our time. Refreshingly, he isn't some sort of billionaire hedge fund recluse. Miller runs an ordinary mutual fund, the $20 billion Legg Mason Value Trust, where he has produced extraordinary returns.
As it stands now, Miller has compiled one of the most remarkable records in the history of investing: His fund has outperformed the stock market for 15 straight years. That's right, 15 years, starting in 1991 - during George Bush the elder's presidency - through the tech bull market, then the crash and now the recovery.
That puts him in the same league as Peter Lynch, George Soros, even Warren Buffett. In recent years Miller has inadvertently added to the drama of his DiMaggio-like streak by falling behind in the first half, only to come roaring back in the fall and pass the market at the last minute.
This year Miller's fund again got trounced by the market in the spring, and since then it has come back, only this time there's a difference. As of early November, Miller was still about 10 percentage points behind the S&P 500. So it is almost certain that he has too much ground to make up and that the streak will be broken. If you don't believe me, ask Miller: "It's unlikely I'll beat the market this year," he says, though he certainly thinks the condition will be temporary.
Running a tight ship
It goes without saying that Miller is an iconoclast. You simply can't do what he's done in the supremely competitive, ultra-efficient world of stock picking by following the pack.
On the outside Miller and his operation look like a standard-issue money management firm - it's a buttoned-down, conservative-looking crew - but spend some time with the man and his brain trust, and you realize that this is more like some sort of academic enclave or wonk house.
Miller's group is just as likely to be discussing the functionality of ant colonies or river systems as P/E ratios. The man runs a required book club for his investment team, for which he assigns works like "Deep Survival," by Laurence Gonzales, and "The Landscape of History," by John Lewis Gaddis.
Miller is chairman of the Santa Fe Institute, a think tank founded to study complexity, for goodness' sake. "The depth and breadth of Bill's intellect is pretty amazing," says Robert Hagstrom, who works as a portfolio manager at Legg Mason. "You watch the guy converse with someone like [American Nobel laureate in physics] Murray Gell-Mann and you ask yourself, 'This guy's a money manager?'" The fact is that Miller has spent decades studying freethinking overachievers, and along the way he's become one himself.
"What we are really trying to do is to think about thinking," Miller tells me. "Understanding how groups behave is central to understanding how complex adaptive systems - such as the stock market - work."
Miller is obsessive about studying what makes certain people and systems different. In simpler terms, Miller, his scholarly protégé, Michael Mauboussin, and the rest of the employees of Legg Mason Capital Management (the arm of Legg Mason over which Miller holds sway) try to understand how investors are wedded to certain beliefs about a stock - say, Amazon.com - that are completely wrong.
If Miller and his people think deeply about it, really deeply and cast aside their biases and maybe their oh-so-human need to think as others do, they might come to the conclusion that Amazon (Charts) is vastly undervalued.
This leads Miller to a dog's breakfast of stocks. Most of what he holds ordinary investors wouldn't dream of owning, everything from newfangled Internet stocks with nosebleed P/Es - yes, he owns Amazon - to butt-ugly down-and-outers like Eastman Kodak (Charts). It's very risky business stuff. Like dancing with a grizzly bear.
Luck or skill?
But how far-out is this really? There are all kinds of money managers who say they "think different." Miller would argue that his group is able to see the world through a truly unique set of lenses by studying how tree limbs grow and how infectious diseases spread and the like, and that this is the value added that allows them to outperform the market.
Does it really? One person who's a little skeptical of the whole business is Miller's boss, Chip Mason, CEO of Legg Mason (Charts), a large asset management company, which has been on a run nearly as spectacular as Miller's fund. I recently spoke with Mason, a no-nonsense type, about Miller's passion for unconventional thinking:
Is it a bunch of malarkey?
Does it matter on the investment side? Marginally, but I do think it's a great escape. It's a way to relax a little or a way to take the pressures away, a way to think outside the box a little bit.... Bill loves that stuff. He's into chaos.
So if you had a money manager who said what we need to do is work for an hour a day and then go surfing for the rest of the day, and I need to take my people with me, and he'd beaten the market 15 years in a row, you would say....
Everybody better get surfing.
Bill Miller owes a debt of gratitude to Pope Gregory XIII. In 1582 the Pontiff decreed that the Catholic world switch from the Julian calendar to the Gregorian calendar that most of the world uses today. Miller seems to have had an uncanny ability to beat the market on a calendar basis.
Two years ago, my colleague Jon Birger wrote in Money magazine that "if the calendar year ended in March, April or any month other than December, there'd be no streak."
In some years he barely squeaked by; last year he beat the S&P 500 by less than half a percentage point. Furthermore, Miller's fund hasn't produced positive returns every year. Like the market, Value Trust was down in 2000, 2001 and 2002.
Another point is that Miller's fund has hardly been a spectacular performer lately. His numbers this year have been so lousy that the fund actually trails the market over the past three years and barely beats it over five.
"It's funny," a knowledgeable New York hedge fund manager tells me. "Bill's thing is to own large-cap U.S. stocks. Those stocks were out of favor for the past few years, and now they're coming back, but not the ones Bill owns."
Why is that? Just bad luck, really. Miller has been doing the same thing he always does, buying stocks he believes in and holding them for years. His turnover rate of about 13 percent barely constitutes trading in his business.
"That implies a holding period of about eight years," Miller points out. "We look for what [Baltimore Oriole manager] Earl Weaver used to love, three-run homers." If Miller likes a stock at $40 and it drops to $30, he likes it even more and often keeps buying as the stock continues to sink. "You don't want to short a stock that Bill owns," says Michael Larson. "You don't have to be long, but betting against him is tough because you'd always be thinking in the back of your mind, 'He must know something I don't.' "
Miller famously backed up the truck and bought AOL in the 1990s when it fell into Wall Street's doghouse. Later it came back with a vengeance. Chip Mason recalls the time: "Bill's basically got ice water in his veins, and he was buying AOL in buckets and it was crashing every day. Scared me. I thought, 'My God, this company's going to go out of business, and we'll have bought a million shares in the last two weeks.' But he was right."
Then there was the time a fund manager asked Miller how low he would keep buying a certain stock. "As long as it still has a quote," Miller replied.
But how does Miller know if a beaten-down stock will be a survivor or a flameout? (The latter is known in the biz as a value trap.) I asked Miller that question back in October one drizzly night in Baltimore's Camden Yards.
The Orioles, a passion of Miller's, were suffering through another dismal stretch, the stands were only a third full, and Miller had no problem following the game and talking stocks too: "You never know for certain, but the nature of value traps is, they tend to have certain characteristics. Typically, one is that the valuation of the business or the industry is lower than its historical norms. The company or business normally has a fairly long history, so the historical normal valuations provide a lot of comfort. Therefore, when you get down toward the lower end of these valuations, value people find them attractive. The trap comes in when there's a secular change, where the fundamental economics of the business are changing or the industry is changing, and the market is slowly incorporating that into the stock price. So that would be the case over the last several years with newspapers. They are a good example of where historical valuation metrics aren't working."
The conversation turns from investing to baseball - which are connected, of course, in that both are susceptible to statistical analysis. In Miller's mind, baseball is another venue for unconventional thinking. ("Moneyball," by Michael Lewis, is a favorite book.)
Miller - a baseball pitcher himself at Washington and Lee, as was Chip Mason in high school - makes no secret of his disappointment with the Orioles' performance. Someday, Miller says, if owner Peter Angelos wanted to sell, he would like to join with Mason and Oriole great Cal Ripken to buy the O's.
(When you suggest to Miller that his streak is DiMaggio-like, he'll tell you he prefers that it be described as Ripken-like.) Miller's dream team to run the Orioles would include Harvard-educated baseball exec Paul DePodesta, who uses nontraditional, so-called sabermetric principles to analyze baseball.
Do Miller and Mason have the cash to buy a Major League Baseball team? Oh, yeah. For starters, Mason owns some $270 million in Legg stock. As for Miller, think about it this way. The Value Trust charges its investors a 0.66 percent management fee. Off a $20 billion base, that's some $132 million of revenue a year. Miller and Legg executives won't say, but certainly Miller gets a major cut of that. And there's more.
As chairman of Legg Mason Capital Management, Miller oversees $40 billion more. Plus Miller is very much the public face of Legg Mason and a constant presence in the company's marketing efforts. Add all this up, and you can be sure Miller makes out just fine as far as compensation goes.
In fact, Miller recently plunked down tens of millions of dollars on a huge yacht called Utopia. It features a heliport, a gym, and a Jacuzzi (and it's available for charter).
Some on Wall Street wonder why Miller has never left to start a hedge fund, but why should he? Sure, he might get even wealthier flying solo, but he does just fine at Legg Mason without the risk of running his own shop. And Miller has created a micro-environment at Legg, in which he appears to have a high comfort level.
At the baseball game that night, Miller is surrounded by a dozen or so young analysts in the Legg Mason box who seem to be acutely aware - almost in a cultlike way - that they are working for the Great Man.
"This is Bill Miller you are talking about," says one of them in a conversation. It's not unusual for Miller to have drinks and socialize with this group until well after the dinner hour.
Miller may be one of the most cool, calm and collected guys you'll ever meet, but he still likes to have a good time. In the morning he often reads at home for a few hours and generally doesn't roll into the office until after 10 a.m. At lunchtime he and his core team - including portfolio managers David Nelson and Robert Hagstrom (who wrote the book "The Warren Buffett Way") - head off to the Grill Room of the Center Club right there on the 16th floor of the Legg Mason building. And the talk is about stocks, baseball and why certain members of the Equidae family don't get stomach pains.
And then there's the male sex organ. "So how do erections work?" says a tiny, longhaired man from a podium. It's a few weeks later, and I'm at the Legg Mason Capital Management Thought Leader Forum, really a behavioral finance conference in Baltimore for a group of about 240 clients and employees, where brainiacs like Emory University psychiatry professor Gregory Berns and Columbia University psychology professor Elke Weber explain their work.
The aforementioned speaker this evening is Stanford neural biologist Robert Sapolsky, a MacArthur fellow (he looks like a character straight out of "Lord of the Rings") and the author of a book called "Why Zebras Don't Get Ulcers."
Zebras are part of the Equidae, or horse, family. Sapolsky is an expert on behavior and stress, and the attendees listen raptly as he explains that zebras are free from ulcers because they get into high-adrenaline states only when they are, say, escaping from a lion.
This is in contrast to some humans who get agitated when they choose the slow checkout line at Whole Foods and then snap at the person ahead of them. The take-away for the Wall Street folks is that stress can affect everything from cardiovascular health to memory to erections, and can also cause bad decision-making.
Most of the money managers in the room seem enthralled by the program. "It's a smorgasbord of brain candy," says Josh Wolfe, a managing partner at Lux Capital. "It makes you wiser, not just in investing but in everyday relationships."
But not everyone has drunk the Kool-Aid. "[Miller's] three-year average has caused some eyes to look his way," says A.C. Berry, an investment analyst with San Antonio Fire and Police Pension Fund. "There is concern [about] performance. I'm here to make sure nothing has changed and to see what the conference has to offer."
The conference is organized by Legg Mason's Michael Mauboussin, a former food analyst and investment strategist at CSFB who's the author of several books and an adjunct professor of finance at Columbia Business School. Mauboussin serves as Miller's intellectual search engine, always looking to bring his master new, brain-stretching ideas.
"There's a never-ending search to figure out ways to gain better insights," Mauboussin tells me. "So I think you look for inspirations, for insights, pretty much anywhere you can think of. Whether it's psychology or science or literature, it's a never-ending search. Bill's currency is ideas. You want to turn him on, give him a good idea. He doesn't care where it comes from. If a Nobel Prize winner gives him a dumb idea, he'll flag it Dumb Idea. And if a junior person gives him a good idea, he flags it Good Idea."
I asked Mauboussin - a tall, handsome sort who worked as a car salesman at his father's dealership growing up - how he measures the effect of what he does. "I think it's inherently very difficult to do. Honestly, that's an ongoing ... not an issue, but it's an ongoing point. The bottom line is whether Bill feels that the work that I'm doing contributes to what he's doing to the organization, to our ability to communicate with our clients and to the broader world. And if he feels those things are being met that would be of value. But I think there's no question that there would be some degree of subjectivity in that assessment."
Miller has a crack team of more traditional stock analysts - co-headed by Randy Befumo, previously employed by the Motley Fool - who blend their work with that of Mauboussin's.
Not long ago it all coalesced beautifully for Miller when the team hit upon buying the Google (Charts) IPO in August 2004. "We were at the Santa Fe Institute in May of 2004 at a lunch buffet," Mauboussin recalls. "And we said we have some incredible people here, let's go to a side room and discuss Google."
The group included Joy Covey, former CFO of Amazon; Gary Bengier, former CFO of eBay; Jim Rutt, former CEO of Network Solutions; John Miller, an economist at Carnegie Mellon; and David Weinberger, a mathematician and former Goldman Sachs arbitrageur. "We kicked it around for a while," Mauboussin says.
"Later that evening, Bill waves me over to speak with David Baltimore, [then] president of Caltech, and he tells us about a great auction theorist he has on his faculty. And we spoke with that guy too."
In July 2004, Legg Mason Capital Management established a Google task force. Befumo wrote a 40-page report, and Mauboussin worked more on the auction theory. "And you may remember Internet stocks were doing poorly then, and the popular press said not to touch this IPO with a ten-foot pole," Mauboussin says.
The Legg Mason team came up with a weighted, laddered bid based on what they believed Google was worth. They bid in three tiers: $150 million, or 1.3 million shares at $116 a share; $100 million, or one million shares at $100; and $50 million, or 561,000 shares at $89.
As it turned out, Miller and his crew were way off - their valuation of the company was much higher than the final price, which was $85 per share. In this case, of course, that meant they hit the jackpot. Legg Mason ended up getting 2.3 million shares (an 80 percent allocation) at $85 - much less than what the team thought Google was worth - and then the stock took off. Today that initial investment of $196 million made in the summer of 2004 is worth $1.1 billion.
Now that's some serious Moneyball.
The end of a winning streak
Not every stock works out like that for Bill Miller. While Qwest (Charts) and AES (Charts) have shone for Miller this year - and energy stocks have come back to earth just as he predicted they would - his portfolio just isn't working for him the way it usually does.
Legg Mason Capital Management owns $1.5 billion worth of Eastman Kodak stock - a staggering 20 percent of the company. Miller began buying the stock in the first quarter of 2000, and it has been nothing but a millstone around his neck (though it's perked up a bit since August).
"That was one where we were wrong to buy it when we did because we underestimated the depth and the speed of the transition," says Miller. "Kodak had known that film was going away long [ago] - they introduced a digital camera, I think, in the early 1990s or late 1980s. The market's not willing to look out a couple of years on anything. We think the probabilities are extremely high that Kodak will have well over $1 billion of free cash flow in two years, but the market isn't going to care until they report that free cash flow."
Other stocks in which Miller has big stakes that have been beaten up this year include Aetna (Charts), which has crashed twice, and UnitedHealth Group (Charts), where longstanding CEO Bill McGuire was forced out over an option-backdating scandal. "McGuire and his team were the real architects of growth there, and the stock attracted a lot of dumb money - that is, money in there just because it goes up every year. If something goes wrong they sell it." Sprint has also been a major drag on his portfolio.
And so it's likely to be a rather glum New Year's Eve this time around for Legg Mason Capital Management. The Streak is probably over. Wouldn't Miller actually prefer that it end to take the pressure off? "No," Miller answers quickly and unequivocally. "I wouldn't be glad that it was over, because it would mean that we didn't add any value to clients that year."
But is the streak a burden? "You mean does it eat at Bill?" asks Chip Mason. "Yes. I don't think horrendously, but it certainly eats at him. Bill and I really don't agree on this. My view last year was, maybe you don't make it and you miss it by 20 basis points - close, it's over, the pressure's gone. His view was, 'You've got to be kidding me. If I'm close, I've got to win!' And certainly I'm not against his winning - my view was, sooner or later, this has got to end. It can't go on forever. Cal Ripken just walked in one day and said, 'That's it, I'm not going to play today,' which was probably right. Just get it over with."
Though the Oriole-crazed Miller might not like to hear it, his streak is really much more like DiMaggio's. Ripken's streak, though mighty impressive, was about showing up to work every day and avoiding injury.
DiMaggio's was about stars aligning. Here's how that streak unfolded: On May 15, 1941, the Yankees hosted the Chicago White Sox, and in the second inning, the home team's unflappable 26-year-old center fielder rapped a single. DiMaggio hit safely in the next two games against the Sox too, and then continued to rap the ball game after game through May. In June he reached base in 20 straight games, then 30, then 40. On July 2, DiMaggio hit safely in 45 games, smashing the record set by Wee Willie Keeler in 1897.
After that the Yankee Clipper was in uncharted territory. No baseball player had connected with a baseball as frequently as this. The nation was captivated and followed every game, and yet even with the pressure mounting day after day, DiMaggio continued to smash the ball. Finally, in Cleveland on July 17, DiMaggio failed to get a hit, lining into a double play with the bases loaded in the eighth inning. By then he had hit in 56 straight games, a record that has stood for decades without really being threatened.
Like Miller, DiMaggio took no comfort in the streak ending. "I can't say I'm glad it's over," DiMaggio said. "I wanted to go on as long as I could." And do you know what DiMaggio did next? He started another streak, hitting safely in 16 straight games.
Reporter associates Corey Hajim and Ellen Florian Kratz contributed to this article.
From the November 27, 2006 issue