celebrity deathmatch: Bill Miller vs. Jon Corzine

the importance of fixing mistakes

My earliest mentor as a portfolio manager continuously pounded into my head the need to find and fix mistakes before they get out of control and destroy your performance.  This is crucial, she said, and she was right.

In her view (I’m simplifying), a good stock might get you 10 percentage points over the index return in a year.  A bad stock, on the other hand, might cost you 30 percentage points before you admit to yourself that you’ve made a mistake and sell.  Therefore, it takes three good stocks to offset the damage done by one bad one.

In other words, common sense says that you’d better spend a lot of time on the lookout for underperforming names in your portfolio.

Why the 3:1 relationship?  Why not 1:1?  I don’t know.  I do know that the bad stocks are uglier than good stocks are pretty.   As to reasons, it may be the professional investor’s disease.  Every time he buys a stock he thinks he knows more than the consensus.  That takes a huge ego.  But the same ego can get in the way of recognizing that you’re wrong.  Or it may just be that when an unfavorable event occurs, holders all rush to sell.  This activity itself depresses the stock significantly.

In any event, it’s PM 101 that you can’t fall in love with your holdings.  You have to develop some way of identifying the clunkers (everyone has them; it’s a fact of life) before they wreck your portfolio.

Miller vs. Corzine

Bill Miller and Jon Corzine are recent instances of famous Wall Street figures who forgot this lesson, with disastrous consequences.

a difference

There is a crucial difference between the two, however.

Every manager knows his asset size, his cash position and his daily inflows and outflows almost to the penny.  A professional trader working on margin knows the size of his equity in real-time and monitors it just as closely.  I find it extremely difficult to believe that an “extra” $600 million or $1.2 billion could plop down into accounts you’re managing without your noticing it.  That’s doubly true if the money is needed to stave off a ruinous margin call.  You’d have to know, in my opinion, and would immediately want to understand where it came from.


What do the two managers have in common, other than their inglorious ends?

Both were very successful for an extended time within the long period of interest rate declines in the US that occurred between 1982 and, say, 2005.  That period, which is over now, taught managers to expect that even extreme risk-taking would eventually be bailed out by lower interest rates.  Neither man seems to me to have understood that this strategy no longer works.

Both appear to have forgotten to play defense.

My guess is that Mr. Miller regarded the recent financial crisis as a replay of the savings-and-loan meltdown that he successfully navigated in the early 1980s.  So he had reason to believe that he had an edge over other, less experienced stock market investors.  Mr. Corzine, on the other hand, strikes me as being more like a professional athlete who returns to the field after a decade working in an office and assumes that he can perform at the major league level from day one.  He seems to me not to have noticed that the other guys were faster, stronger and had instincts honed by never having fallen out of game shape.

In a lot of ways, professional investors are like kids playing video games.  Firms that employ them typically recognize this and install checks and balances that either force them to consider the business consequences of their actions or set portfolio parameters beyond which they are not permitted to go.  Both Miller and
Corzine seem to me to have been so deeply entwined in the management of their firms, however, that the firm’s risk controls were overridden.

Both are cautionary tales for investment professionals.

Bill Miller and the Legg Mason Capital Management Value Trust mutual fund

Last week, Bill Miller of Legg Mason announced that he is stepping down as portfolio manager of that firm’s Capital Management Value Trust fund after 20+ years at the helm.

Mr. Miller was once the envy of equity portfolio managers everywhere for the fame and fortune his beating the S&P 500 for 15 years in a row brought hi.  In recent times, he has become the embodiment of very pm’s worst nightmares, however.

His previously hot hand–which had earned him designation by Morningstar as a “Manager of the Decade” turned icy-cold in 2006.  Ensuing weak performance erased the gains in relative performance his portfolio had made since “the streak” began in 1991.  The assets in his fund fell by almost 90% from the peak of $21 billion +.

my thoughts

I should say at the outset that I don’t know Mr. Miller and that I haven’t studied his portfolio composition carefully.  And I’m not interested enough to look up his past SEC filings to try to document my impressions.  With that warning, here’s what I think:

1.  It took Legg Mason a very long time–and the loss of the vast majority of Value Trust’s assets–before it made the change.  At the asset peak, the fund was generating management fees for LM at a $140 million annual clip.  It’s now generating under $20 million.

Why not act sooner?

Part of the reason is likely that after sagging in 2006-2008, the Value Trust outperformed in 2009.  More important, I think, is that the fund’s marketing has been all about “the streak” and the extraordinary investing prowess of Mr. Miller.   It’s a good story and an easy sell.  But it’s a risky strategy.  If it’s all about the numbers, and someone with even better results comes around–and invariably someone will–what do you do? You’ve already made the argument to your client to switch into the Value Trust because of the numbers; how can you now argue against numbers that tell him to switch out?

This selling direction also gives the manager himself a huge amount of power.  What’s the Bill Miller show without Bill Miller?  So if Mr. Miller wants to continue to run a concentrated portfolio with a strong emphasis on financials, despite steady underperformance, how do you stop him not to?

2.  I’ve never regarded Mr. Miller as a typical value investor, although he’s always described as one and the Value Trust (note the name) is classified with other value vehicles by rating services.  I have two reasons:

–Value investors are belt-and-suspenders kind of guys.  They run highly diversified portfolios, typically with 100-200 names–sometimes more.  Growth investors, in contrast, typically hold 50-60.  Looking up the Capital Management Value Trust on Google Finance told me it has only 46 names. (By the way, in my experience ratings services never pick up high concentration as a source of risk.)

–Both value and growth investors look for “undervalued” securities (only shortsellers want to find overvalued stocks).  That isn’t what the “value” in value investing signifies.  It means a certain approach to finding undervaluation.

Value investors look at the here-and-now.  Their holdings are typically asset-rich companies that have encountered temporary difficulties, which have been crushed by Wall Street and which are now trading at unduly depressed valuations as a result.  Growth investors, in contrast, look for companies whose future earnings prospects are being underestimated by the market.

In this sense, too, I don’t think Mr. Miller is a plain-vanilla value investor.  He has been happy to hold large positions in stocks like Amazon or AOL (in its heyday)–names I think other value practitioners wouldn’t give a second look because the whole story has been the rate of future earnings growth.

I have no idea how Mr. Miller squares this circle.  (The fund’s largest positions are now in technology, according to Google Finance.  But it’s not the same thing.  Today’s stocks are eBay and Microsoft.  Apple, the largest holding, is still a growth stock, unlike the others.  But AAPL trades at a very low PE multiple of current earnings.)

3.  Despite this flexibility, and the issue of heavy concentration aside, it seems to me that classic value behavior has been the Value Trust’s recent problem.  Relative to history, financials were trading at low price to book value (i.e., the balance sheet value of shareholders’ equity) ratios when Mr. Miller bought them.  In hindsight, that was a mistake.

There may have been a second.  If the stocks a growth investor buys underperform, he typically stops buying or lightens up.  Value investors tend to do the opposite.  They regard such stocks as being even cheaper than when they initially bought–and double up.  I suspect the latter is what Mr. Miller did.

two oddities

1. In the early part of my career, alternating cycles of outperformance by value and growth stocks were relatively brief.  Given a year, or two at the most, there would be little to chose between the numbers generated by one style or the other.  The 1990s, however, saw a multi-year value cycle in the early part of the decade, followed by a massive multi-year growth cycle–culminating in the Internet Bubble–at the end.  Despite the fact that the tide was running strongly against value during the latter years, Mr. Miller continued to outperform the S&P 500.  If he did so with value stocks, that’s his crowning achievement.

2.  After creating a strong business franchise under the Miller name, neither he nor Legg Mason did much to protect it.



brain drain in 2012

what it is

“Brain drain” is a term coined in the UK after WWII to describe the outflow of human intellectual/scientific/economic talent from a country.  Motivation for the outflow can sometimes be religious or ethnic persecution in the home country.  More benignly, brain drain is more likely motivated by economic prospects that are perceived to be significantly better away from the home country.  According to Wikipedia, the term may have been initially used to describe the movement of British citizens to the US, or to the inflow into the UK of citizens of India.

where is it happening today?

What forms of brain drain can be seen in today’s world?

the Eurozone

–I think we should watch the EU carefully, especially southern Europe.  On the one hand, government finances in Italy, Greece… can’t be fixed by raising taxes.  People will move into other parts of the Eurozone, for one thing,  History also shows that higher tax rates invariably trigger increased tax evasion.  So higher rates can end up generating lower revenue.  (This isn’t just a European phenomenon:  New Jersey has just released an economic study showing the state is suffering a net loss of $150 million in annual tax revenues as a consequence of two income tax rate hikes early in the last decade).

Even though cost-cutting will be the main tool European governments will use to balance heir budgets, the economic stagnation that austerity measures will produce may cause an outflow of intellectual talent from southern Europe to France or Germany, or outside the Eurozone to the UK.

the US

–Anecdotal evidence suggests there’s a budding trend toward emigration from the US to China, because of the latter’s superior economic prospects.  There’s also a movement on the Northeast to create publicly funded schools that emphasize Asian culture and history–and where instruction might be in Mandarin.

–a combination of high taxes, lack of home-grown engineering graduates and immigration restrictions that severely limit the number of Indian and Chinese engineers able to work in the US has meant a continual outflow of technology manufacturing away from the US.


–To my mind, the most curious case of potential brain drain is that recently reported by the Wall Street Journal It’s the potential outflow of wealthy Chinese from the mainland.  They’re not seeking political or economic freedom, or at least not simply that.  What’s prompting them to consider emigration–overwhelmingly to either the US or Canada–are social concerns, including:

–poor schools

–bad medical treatment


in that order.  Also:

–unsafe food (local municipal authorities sometimes offer industrial waste disposal sites for lease as agricultural land), and

–the one-child policy.

investment implications

At this point, these developments are more curiosities than anything else.  But events in southern Europe bear close watching.  That’s the place where emigration has the most potential for economic disruption, in my opinion.