Dollars and Jens
Tuesday, February 06, 2007
Bill Miller
Calendar year 2006 was the first year since I took over sole management of the Legg Mason Value Trust in the late fall of 1990 that the Fund trailed the return of the S&P 500. Those 15 consecutive years of outperformance led to a lot of publicity, commentary, and questions about "the streak," with comparisons being made to Cal Ripken's consecutive games played streak, or Joe DiMaggio's hitting streak, or Greg Maddux's consecutive years with 15 or more wins, among others. Now that it is over, I thought shareholders might be interested in a few reflections on it, and on what significance,if any, it has.

A common question I've gotten is whether I am in some sense relieved that it is over. The answer is no. Active managers are paid to add value over what can be earned at low cost from passive investing, and failure to do that is failure. We underperformed the S&P 500 in 2006 and did not add value for our clients and shareholders. It is little consolation that most mutual fund managers failed to beat the index in 2006, or that most managers of US large- capitalization stocks fail to outperform in most years, or that under 25% of them can outperform over long periods such as 10 years, or that the next longest streak among active managers going into 2006 - 8 years - also ended this year, or that it is believed that no one else has outperformed for 15 consecutive calendar years. We are paid to do a job and we didn't do it this year, which is what the end of the streak means, and I am not at all happy or relieved about that.

There was, of course, a lot of luck involved in the streak... If beating the market was purely random, like tossing a coin, then the odds of 15 consecutive years of beating it would be the same as the odds of tossing heads 15 times in a row: 1 in 215, or 1 in 32,768. Using the actual probabilities of beating the market in each of the years from 1991 to 2005 makes the number 1 in 2.3 million. So there was probably some skill involved. On the other hand, something with odds of 1 in 2.3 million happens to about 130 people per day in the US, so you never know.
His fourth-quarter commentary is online (PDF).
It is trying to invest long-term in a short-term world, and being contrarian when conformity is more comfortable, and being willing to court controversy and be wrong, that has helped us outperform. "Don't you read the papers?" one exasperated client asked us after we bought a stock that was embroiled in scandal. As I also like to remind our analysts, if it's in the papers, it's in the price. The market does reflect the available information, as the professors tell us. But just as the funhouse mirrors don't always accurately reflect your weight, the markets don't always accurately reflect that information. Usually they are too pessimistic when it is bad, and too optimistic when it is good.
(Emphasis added.)

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