Last week, Bill Miller got it right when it comes to getting things wrong.
The legendary manager of the Legg Mason Value Trust – the only mutual fund to beat the Standard & Poor’s 500 index for each of the past 15 years – started his quarterly letter to shareholders by saying the fund “had a dreadful second calendar quarter.”
He was right. The fund was off 5.67 percent in the second quarter; it has lost nearly 9 percent this year, making it pretty much the worst large-cap stock fund out there in 2006. The winning streak looks like it will end this year, as Value Trust trails the index by more than 12 percentage points.
Miller’s statement stands out not only because he ripped himself but because he made it clear precisely how and why he had failed, suggesting that he had delved too deeply into big-name Internet stocks and had stayed out of the high-flying energy sector. He was unapologetic; while it’s clear that he wants results to improve, it’s equally clear he won’t change his ways.
Most fund managers get it wrong when they get things wrong. After making money-management mistakes, they make excuses, act indifferent to performance or make knee-jerk changes that overreact to the scope of the problem.
Miller has been around long enough to know that investors won’t flee his fund, kind of how Warren Buffett knows he can talk frankly about his stretches of bad performance without losing the respect of investors.
Not every manager has that kind of tenure, record or self-confidence.
So when your fund’s quarterly note to shareholders arrives, look to see if your manager is coming clean or covering up. Your spider senses should tingle – warning you that danger is near – if your fund is down and you see some of the following:
“It’s a challenging market right now.”
The other variation on this is “It’s a stockpicker’s market.”
Investing is always challenging, even when the market is booming. Selecting the top performers is what separates the winners from the pack, whether stocks are flying or sinking. If you have bought a fund for the manager’s expertise, you presumably expect them to deliver good performance relative to the competition, and regardless of market conditions; a manager who blames the stock market is telling you that “it’s not a good time to be relying on luck.”
“We underestimated the risk … .”
Managers sometimes use this one to explain how they blew it, most often by concentrating the portfolio in one area (say technology).
The manager’s job is to take risk into consideration appropriately. You want a manager to do as Miller did in explaining his aversion to energy stocks; feeling they were overvalued, Miller effectively overestimated the risk, which is appropriate for a value manager.
Better to invest in a way consistent with a fund’s long-term mission than to fail to properly consider risk and blow up taking too many big chances.
“We’re cautiously optimistic … .”
Ick. The most overused phrase in the fund manager lexicon is meaningless.
If the manager told you they expected to lose a fortune, you wouldn’t invest with them. If they told you they expected to make a fortune, the corporate lawyers would gag them, fearing lawsuits if the fund can’t deliver.
That means that all fund managers are cautiously optimistic.
“The long view of our performance shows … .”
When a manager turns the shareholder letter in this direction, treat it as if the firm is running a misdirection play.
The quarterly letter is designed to talk about results and future prospects. Managers should acknowledge when they’re struggling, not gloss over it.
“We’re taking steps to improve returns.”
This is another statement that managers should make regardless of market conditions or recent performance – because the manager who has stopped trying to get better has given up – but it’s also a warning sign.
Miller noted that, despite his fund’s troubles in 2006, he was not going to move away from the fundamental strategies that have worked for years.
If a manager starts talking about changes they have made, look closely to see if the fund is about to change its stripes. If a manager no longer believes that their methods will lead to good returns, why should you?
The best way to improve your returns at that point is to no longer rely on the manager, but to make a change.
Chuck Jaffe is senior columnist for MarketWatch. He can be reached at jaffe@marketwatch.com or at Box 70, Cohasset, MA 02025-0070.
