Lynn Carpenter

Maybe it was a typo.  But knowing my husband Andy, maybe the subject line “Ill Miller” was a pun.

Last January, it was official.  Bill Miller of Legg Mason Value Trust failed to beat the S&P 500 in 2006.  Thus ended a 15-year streak of beating the market, an all-time record run among fund managers.  Headlines blared.  Pundits jabbered for months before and after.

But it’s been suspiciously quiet this year, after Miller pulled up short of the S&P again.  Why is that?  I suspect a good many people are prematurely glad about Miller’s miss and the opportunity to write him off.  They are not your friends.  Miller validates us rational investors and proves we’re on the right track.

For 15 straight years, Miller’s performance was so far out front that some folks just didn’t believe talent had anything to do with it.  College finance professors must have felt the same way about Bill Miller’s performance that I do when watching an NBA game.  Even when I’ve seen them myself, some of those twisting, turning, in the air, through a picket fence of opponents’ arms shots just can’t be real.  They are so theoretically impossible in light of my own biomechanics they’re impossible to accept.  

In business schools, where professors who teach investing aren’t scored on their investment results, Miller is the monkey who accidentally typed Gone with the Wind.  He’s the guy who threw heads 100 times in a row, which is just a statistical fluke, not really a demonstration of penny-tossing flair.  Because in business school, they still tell the children that it is impossible to beat the market. This, of course, is convenient for professors who don’t have to demonstrate they know what they’re doing.

Now the theoreticians are even happier.  In the recently expired 2007 investment season, Miller not only came in below the S&P, he lost money.  Whoa!  Is Miller through?  Was his good run just an accident after all?

Fortunately, I happen to have a book or two on that.  One’s out of date, but the lessons still apply.  It’s Robert Hagstrom’s The Warren Buffett Portfolio.  The same information or variations on it turn up in other Hagstrom books and elsewhere.

In TWBP, Hagstrom lists the yearly the track records of a handful of famous “focus” investors who stick to fundamental value and keep small, long-held portfolios.  Hagstrom calls them the “Superinvestors of Graham and Doddsville.”  That’s a takeoff on a famous speech that Buffett himself gave at Columbia Business School.  The group of superinvestors is small.  Two of the five members are dead.  The other three are long in the tooth.  And one of them, Charlie Munger, says that Bill Miller, a kid by comparison, belongs with them.

Though he’s a little wilder than the original five, Miller has the superinvestor style.  He believes in keeping a fairly compact portfolio.  He tends to hold 30-40 stocks rather than 10-20, but that’s downright tiny for a fund manager these days.  More importantly, he keeps what he buys for a long, long time.  And if Munger is right about Miller, I wouldn’t bet on Miller taking a beating by the S&P much longer.  Miller’s not the only one who has proved it’s possible to beat the market with careful stockpicking.

Who are these superinvestors?  As you might have supposed, one is Warren Buffett and another is Charlie Munger, Buffett’s partner at Berkshire Hathaway.  A third is related to those two - Lou Simpson, who runs the GEICO portfolio.  GEICO, of course, is wholly owned by Berkshire Hathaway.  These three are still going strong.  The fourth member of Hagstrom’s superinvestors was Bill Ruane, who ran the great Sequoia Fund before he died in 2005.  Finally, there was that economist that Austrian School economists love to hate - John Maynard Keynes.

The superinvestors far outpaced their peers in time frames ranging from the 1920s to the early 1980s.  Some are still outpacing them.  But not without some wild variations and some bad years ...

• Lou Simpson failed to beat the S&P in five of 17 years.  But he averaged 24 percent a year compared to 17 percent for the S&P.

• Charlie Munger, via the Munger Partnership, averaged 24 percent as well, but he underperformed the S&P in five of 14 years.

• Bill Ruane averaged 18 percent during a time when the S&P averaged 13 percent; he fell below the S&P in 10 of 27 years.

• Keynes, being a Brit, made 13 percent during a period when the London Exchange averaged a negative 0.2 percent.  He missed his index in seven of 17 years, and some of those were huge slips.  His “Chest Fund” was worse than the market for its first four years as he bought cheap stocks on the way down.  Then in the fifth year, Keynes made 44 percent while the market still tumbled.  But he also lost 40 percent one year when the market dropped only 16 percent.

This puts Bill Miller and any of us who manage tidy, long-term portfolios in a much better light.  Wall Street would like you to either put your money in an index fund and go away, or churn like crazy so they can make money on your commissions and spreads.  Neither is good for you, though it’s hard to believe. 

It seems that it should be possible to speculate for the short term and continue beating the market.  After all, you would be constantly dropping the out of favor and loading up on high momentum.  But no momentum investor has ever achieved superinvestor returns over the long run. 

Big returns come from two decisions: buy what’s worth buying as a long-term prospect, then hold on.  Sooner or later, that will mean a bad year - as anyone who has financial stocks has learned this year, not to mention anyone with housing stocks.  But in the end, focus and persistence are worth the bumpy ride.

How much? Well, let’s take Ruane’s modest 18-percent return compared to the S&P historical average.  These are numbers you can shoot for.  Now give it 15 years.

The results?  Being like Ruane would turn $10,000 into $119,737.  Doing market average would result in only a $47,846 nest egg.

Clearly, if you have already chosen companies you consider great, and they are still performing well and have strong long-term outlooks, you want to be like Ruane … and Munger … and Keynes … and Simpson … and Buffett …

And Ill Miller, too.

Sincerely,

Lynn Carpenter

P.S. I hope you took the Two Best Medical Stocks for 2008 report I offered you last week.  Not many stocks have gone up in the last week, but Medical Stock #2 is up 13 percent.  Read the report now if you missed it.  It’s totally free - my gift to you to say hello.  Because there’s more upside to come and you can enjoy it, too. 

P.P.S.  To let me know what you thought of today's article, send an e-mail to: feedback@investorsdailyedge.com.