Below is Part 2 of a five-article write-up regarding legendary investor Bill Miller, CFA, during the 2006 Financial Analysts Seminar, hosted by the CFA Institute. In case you missed it, be sure to check out Part 1 of the series.
Is the market efficient?
The seminar moderator asked whether Bill Miller believes in any form of the efficient market hypothesis (EMH), be it the weak, semi-strong, or strong variety. If you recall, the EMH debates the degree to which the market reflects all available information about a company and whether an investor should be able to outperform the market. For example, the strong-form EMH believes that the stock market discounts all public and private information very quickly and that it is impossible to "beat" the market. Fools and active managers generally disregard each form of the EMH, as does Miller.
Miller stated that he believes the market is "pragmatically efficient," meaning that although he believes a manager can outperform the market, it is no easy task, since investing is extremely competitive. With so many managers mercilessly compiling and interpreting all available information, it is very difficult to earn market-beating returns, as witnessed by the fact that the average manager will return below the market, especially as time progresses.
Embrace active management
Nevertheless, and as you would expect, Miller praised active management as a worthy endeavor. His view of passive management is that it guarantees underperformance. This is because passive strategies only aim to match the market return, so after subtracting management fees, the investor has effectively locked in underperformance. And as time goes on, that gap continues to widen as years of underperformance compound. In his view, the only chance an investor has of beating the market is to actively embrace trying to beat the market.
Additionally, Miller finds no use in striving for diversification or minimizing tracking error by holding exposure to each industry included in the S&P 500. He doesn't concern himself with sector exposure and openly questioned why he would want to guarantee exposure to the worst industries. That's the value-add of an active manager. By doing their jobs correctly, managers should successfully avoid the pitfalls in the market, making themselves and related clients wealthy.
A long-term focus
Miller detailed his pursuit of "time arbitrage" to increase his probability of outperforming the market. In other words, looking out two, three, or five years is a potentially advantageous strategy in a marketplace where most investment professionals are myopically focused on what happened this quarter or what may occur next quarter. Many managers don't look more than 12 to 18 months ahead. As such, they devote less time and manpower to thinking about future scenarios, implying less efficiency and a less likelihood of outperforming.
Frequency versus magnitude
Miller believes it's extremely important to distinguish between the frequency and magnitude of events. To use an analogy, he referred to baseball player Earl Weaver, who stated that more games are won by a three-run homer (large-magnitude hits) than by the more common bunts and singles (high-frequency hits). He explained that investors focus more on frequency, or how often they are right. However, what is important is the magnitude of their correct decisions, or how much money is placed on the right bets. Investors can be right many times, but if they placed most of their capital on a bet that went down, then their overall wealth has decreased.
Miller offered a final baseball reference, stating that he is focused on slugging percentage, not batting average. That means he wants to make lots of productive hits, not just lots of hits.
Best, worst, current stock picks
The most successful investments during Miller's tenure have been AOL (now part of Time Warner
Miller was also asked how he knew when he made an incorrect stock pick. To much crowd laughter, he said you know things haven't gone well when you can't get a quote anymore. This occurred when he purchased shares in Enron in late 2001 on a hunch that it may be able to recover if it could maintain access to the capital markets. His $300 million commitment went up in smoke, but he stated that the team calibrated its position so it could still outperform for the year, which it did.
Other holdings of the Value Trust that Miller discussed include IAC/InterActiveCorp
Fool contributor Ryan Fuhrmann is long shares of Time Warner but has no financial interest in any company mentioned. The Fool has an ironclad disclosure policy. Feel free to email him with feedback or to discuss any companies mentioned further.