Recentism is an affliction that besets most investors. Chasing yesterday’s performance in the hope/belief it will deliver the same and more in the future.
Many a ship has been wrecked on rocks of extrapolation.
Bill Miller was the only US fund manager to beat the S&P 500 index each and every year from 1991 to 2005. Fifteen straight years of outperformance is very impressive.
Miller’s fund – Legg Mason Capital Management Value Trust – was the investors darling.
During his heyday Miller was described as a ‘genius’. With hindsight Miller’s extended period of outperformance actually came from taking some big (and at the time, successful) bets on some high-tech companies.
Some would argue he got it right so what’s the problem? Well how do 1990 style high-tech companies fit under the ‘Value Trust’ realm? Value investing is supposed to be about identifying companies with strong earnings and assets that are trading at a discount to their book value.
It is this type of misleading product definition that confuses the hell out of retail investors. You think you are getting a certain investment style only to find out (too late) that the fund manager did not practice what the product description preached.
How did it turn out for Bill? Here’s the LMVTX chart from Yahoo finance.
Since 2005, Miller has fallen well behind the index. Investments in Countrywide, Citigroup and Yahoo have seriously detracted from the performance of the fund.
The fund’s current price is back to levels first reached in 1999. Chasing past performance can be dangerous to your wealth.
With hindsight, Miller ‘genius’ tag should have been a warning to investors to grab a copy of Roger Lowenstein’s When Genius Failed: The Rise and Fall of Long-Term Capital Management.
Long-Term Capital Management (LTCM) certainly warranted the genius tag. The firm – established in 1994 – had professors and two Nobel Prize winning economists on its management staff.
The boys with the smarts certainly did not disappoint the punters. According to Wikipedia: ‘Between 1994 and 1998, the fund showed a return on investment of more than 40% per annum.’ Not bad. This type of success certainly attracted investors.
At its peak – three short years after opening its doors – LTCM managed in excess of $100 Billion. For a little perspective on that achievement – Colonial First State was established 25 years ago and has approx. $150 billion under management.
LTCM was marketed as an ‘absolute return’ fund -a fund that is meant to make positive (absolute) returns irrespective of the market conditions.
Unfortunately, genius failed. The 1997 Asian Crisis followed four months later by the 1998 Russian crisis combined to force the liquidation of LTCM – four short years after its dazzling debut.
Given its brief tenure, the firm should have been named the ‘Short-Term Capital Management’ and marketed as an ‘absolutely no-return’ fund.
But it is not all bad news on the investment management front. Warren Buffett is an investment genius. Buffett’s company, Berkshire Hathaway Inc., has a market cap of $281 billion.
In 1965 Buffett acquired 49% of Berkshire’s common stock and named himself a director. Since then the Berkshire Hathaway share price has compounded at an average annual rate of 19+% per annum. By comparison the S&P 500 index had a compound return of 9.4% per annum.
The following chart (courtesy Yahoo Finance) shows Berkshire’s share price rising from $5000 in 1990 to around $175,000 today – an increase of 35x.
While Bill Miller road the coat tails of the tech boom, Buffett watched from the sidelines. Berkshire Hathaway investors, anxious to participate in the boom, did the unthinkable and openly questioned Buffett’s investment ability.
‘Investor Warren Buffett took a pasting for ignoring the 1999 surge in dot.com stocks.’ –
BBC News March 2001.
Compare Miller’s performance to Buffett’s and we know who has had the last laugh.
There is no question Buffett (and his business partner Charlie Munger) have delivered exceptional value to their investors – far in excess of the index.
We know this with the benefit of hindsight. The difficulty for investors is trying to select in advance which genius is genuine or flawed.
LTCM and Miller both outperformed Buffett during the 1990s.
LTCM’s star burned very brightly for a little while but faded spectacularly. Miller stayed around for a while but his luck ran out when the ‘hot’ market cooled.
Buffett has been the stayer. His 50-year track record speaks for itself.
With the tech boom in full flight, ask yourself honestly which fund manager you’d have chosen in the mid to late 1990s to manage your funds?
From my experience at the time, I’d guess the majority would’ve gone with LTCM and Miller.
Individual investors and fund managers are prone to chase out performance.
So unless you are astute or lucky enough to identify a Warren Buffett style manager before he becomes a Warren Buffet, then the next best approach to long term investing is tracking the index.
Yes there are going to be the managers who do manage to beat the index consistently. LTCM did it for a few years and Miller managed it for 15 years.
However, countless studies have shown the longer the time frame, the lower the percentage of managers who can deliver superior results to the index.
Do you want to trust your capital to the very slim odds of finding the next Buffett or risk the greater odds of investing in ‘today’s rooster and tomorrow’s feather duster’?
It is for this reason the Gowdie Family Wealth model portfolio consists of index Exchange Traded Funds. Understanding and managing the downside in your portfolio is far more important than the dreamy prospects of picking tomorrow’s next big winner.
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