A 5 Star Fund Manager Can't Beat The Market

If a 5 Star fund manager can't beat market, how can you expect to beat the market? Bill Miller, fund manager with Legg Mason Inc, had almost $200 million invested in Bear Sterns with his Legg Mason Value Mutual Fund. As of Thursdays close, the value of the Fund's holding was down to $15 million, a loss of 90%.

Legg Mason Value has hit a bit of a rough patch lately. Since 2006 the fund has lagged the S&P 500. Below is a table of the funds returns:

Investment	YTD (1)	3 Month (1)	1 Year (2)	3 Year (2)	5 Year (2)	10 Year (2)
Legg Mason Value	-17.70%	-17.35%	-9.31%	1.33%	10.83%	7.92%
S&P 500	-9.05%	-9.68%	5.49%	8.62%	12.83%	5.91%

1. Returns as of February 29, 2008
2. Returns as of December 31, 2007
3. Source: Legg Mason

From 1990 to 2005, Bill Miller had beat the S&P 500, and over the inception of the fund it has beat the S&P 500 by 3.72%, annualized. (These returns are through December 31, 2007 and no not account for taxes, fees or expenses.) Towards the end of ever year during the streak, a news story would pop up noting the streak and asking the question 'Will he beat it again?". In 2006 the Fund's streak ended.

So what has changed for the fund? As far as I can tell, Mr. Miller is sticking to his stock picking approach, looking for stocks that are undervalued with good growth prospects. He also maintains a fairly concentrated portfolio, which increases the volatility. As of December 31, 2007 the Value Trust fund held just 48 stocks, with 47% of the funds assets in the top ten holdings.

The fund has almost 40% of its assets in Consumer Services and Financial Services. These two sectors have been hit really hard due to the current problems with the economy. Mr Miller jumped into some of his stock picks too early, and did not anticipate the severity of the credit crisis. This fault is easy to pick up with the benefit of hindsight.

An article in the WSJ notes:

Regarding recent missteps, Mr. Miller is essentially re-employing his strategy from the early 1990s -- an important reference point that's informed some of his boldest buys.

Back then, a similar crisis was unfolding in financial markets and Mr. Miller eventually swooped in to buy money-center banks like Chase Manhattan and Citicorp that he thought were underpriced, as well as insurance companies and mortgage lenders. Financials made up as much as 45% of Mr. Miller's portfolio by the mid-1990s, and helped drive his 15-year winning streak as they rallied over the years.

In his latest shareholder letter, Mr. Miller notes "the past two years are a lot like 1989 and 1990," with a "reasonable probability the next few years will look like what followed those years."

Source:
http://www.leggmason.com/individualinvestors/products/mutual-funds/performance/LMVT.aspx
http://prospectus-express.newriver.com/pnet/get_template.asp?clientid=legg&userid=&fundid=524659109&doctype=pros
http://online.wsj.com/article/SB120605842099153423.html?mod=todays_us_money_and_investing

Additional Reading:
"Where Art Thou Bill Miller", Motley Fool
"Bear Stearns's Demise" Felt by Many Fund Holders", Smart Money
"Stick with Bill Miller", Market Watch

Stock Market Volatility

If you have kept your eye on the stock market lately you may have noticed that it has been extremely volatile. Just within the past week the S&P 500 has closed up 4.20% and had two days where it closed down by more then 2.00%. Below is a chart of the S&P 500.

Source: finance.google.com

Volatility Index

A way that this volatility can be measure is by the VIX, Volatility Index, which is a benchmark index driven by option prices on the S&P 500. The index was developed by the Chicago Board Options Exchange in 1993 and is based on real-tme option prices and measures the expected near term (30-days) volatility of the market. The CBOE explains the index as follows:

VIX is based on real-time option prices, which reflect investors' consensus view of future expected stock market volatility. During periods of financial stress, which are often accompanied by steep market declines, option prices - and VIX - tend to rise. The greater the fear, the higher the VIX level. As investor fear subsides, option prices tend to decline, which in turn causes VIX to decline.

Below is a chart comparing the VIX to the S&P 500 back to January 1990. It is interesting to see the relationship between a decrease in the VIX and increase in the S&P 500 on the last third of the chart. For the past several years, the market has experienced a period of relative calm, or the "Great Moderation." This was a period of time marked by easy credit, real estate became the next bubble, and investment banks developed all types of synthetic securities. It seems that risk left the vocabulary of investors.

Source: cboe.com/VIX

Are We Entering A Period Of Renewed Volatility?

The WSJ had an article which discusses "Great Moderation" and the possibility that we may be entering a period of volatility. The article provides a nice analogy of risk.

That raises the question of whether the idea of a Great Moderation led to its own undoing. As volatility fell, risk-hungry investors and trigger-happy policy makers spent a lot of time patting themselves on the back. Fed officials talked up a more rosy economic landscape and confidently pushed interest rates to historic lows, sure they could fix any problem. Investors witnessed it all and made riskier bets, depending on ever-more debt, to boost their returns.

The compression in volatility was like pushing down on a spring. Now it's sprung. We're probably in the second recession this decade. And the Fed is lowering rates again.

What Is The Average Investor To Do?

For most average investors, there probably isn't anything that you should do. Hopefully, you have determined the level of market risk your are comfortable with and have allocated your investments appropriately. If you have an automatic investment purchase plan set up and a longer time horizon, enjoy the opportunity to buy additional shares at cheaper prices.

If your approaching the time when you will need your money and our uncomfortable with the volatility, look to move your money to more secure investments. With the Fed dropping interest rates, most savings accounts, money market accounts and CDs are barley beating the inflation rate. One option might be to invest in Treasury Bonds or dividend paying stocks. One of the great things about stocks that pay a nice dividend, is that you get pay to wait for any capital appreciation.

Source:
http://www.cboe.com/micro/vix/introduction.aspx
http://www.cboe.com/micro/vix/vixwhite.pdf
http://www.cboe.com/micro/vix/pricecharts.aspx
http://online.wsj.com/article/SB120588597399047123.html?mod=todays_us_money_and_investing {$$$}

Fed Drops Rates...Again

Yesterday the Federal Reserve dropped the Federal fund rate 0.75 percent to 2.25 percent. This was less than the 1 percent people were hoping for. The stock market did not seem to mind, rallying 420.41 points to close at 12392.66. The WSJ notes that the futures market is expecting additional cuts which would bring the Federal Fund rate down to 1.50% to 1.75%.

Since the beginning of this latest round of rates cuts, the rate has dropped from 5.00% to 2.25%. Below is a nice little graphic from the WSJ.com showing the drop in the Federal funds rate & the Discount rate.

Source: WSJ.com

Below is another chart comparing this round of rate drops to other recent easing cycles. The Fed has cut rates quickly dropping 3% points in 120 days. In 2001, the last time the rates dropped this much, it took over 160 days.

Source: WSJ.com

These rate drops are great if you are looking to take out a loan or have a variable rate loan, not to good if you have large amounts of cash sitting in a bank account. Bankrate.com has a series of articles noting the winners and losers of the latest interest rate cuts. They reiterated my point that new borrowers or those with variable rates are the winner and those with cash are losers.

They quote William Larkin, a fixed income portfolio manager at Cabot Money Management in Salem, Mass: "The Federal Reserve has clearly signaled that they're going to throw savers under the bus."

Below is a chart from Bankrate.com showing the drop in national CD and MMA rates over the three months. Not too encouraging for savers.

Source: Bankrate.com

Source:Bankrate.com

With interest rates so low, where do you put your money to work? One place is the stock market. Before yesterday the stock market was approaching the 20% decline that people consider as a bear market. To paraphrase Baron Rothschild the best time to buy is when there is blood in the streets. Below is a chart of the S&P 500 over the past three months.

Source: Yahoo.com

It seems that this post has a nasty habit of inserting graphs that are all going in the downward direction.

Source:
http://online.wsj.com/article/SB120586224310945729.html?mod=todays_us_page_one {$$$}
http://www.bankrate.com/brm/news/fed/winners-losers_Mar182008.asp?s=1&caret=3

Economic Stimulus Payments

The IRS issued a news release providing information on when they will begin sending out the econmic stimulus payments. The IRS will begin to send out the checks on May 2 and expect to be completed with the initial round of weekly payments by early July.

Below are the schedules for economic stimulus payments related to tax returns processed by April 15, 2008.

Direct Deposit Payments
If the last two digits of your Social Security number are:	Your economic stimulus payment deposit should be sent to your bank account by:
00 – 20	May 2
21 – 75	May 9
76 – 99	May 16
Paper Check
If the last two digits of your Social Security number are:	Your check should be in the mail by:
00 – 09	May 16
10 – 18	May 23
19 – 25	May 30
26 – 38	June 6
39 – 51	June 13
52 – 63	June 20
64 – 75	June 27
76 – 87	July 4
88 – 99	July 11

Part of the press release noted that there is an online calcuator to determine if you are eligible for the payments and if so how much you can expect to recieve.

Source:
http://www.irs.gov/newsroom/article/0,,id=180247,00.html

More Good Economic News?

From Bloomberg this morning:

U.S. Unexpectedly Lost 63,000 Jobs in February

The U.S. unexpectedly lost jobs in February for the second consecutive month, adding to evidence the economy is in a recession.

Payrolls fell by 63,000, the most in five years, after a revised decline of 22,000 in January, the Labor Department said today in Washington. The jobless rate declined to 4.8 percent, reflecting a shrinking labor force as some people gave up looking for
work.

``All the lights are flashing red,'' said Nariman Behravesh, chief economist at Global Insight Inc. in Lexington, Massachusetts, in an interview with Bloomberg Television. ``We're in a recession. I don't think there is any doubt about it at this point.''

Monthly Unemployment

Monthly Payrolls

Source: Bureau of Labor Statistics

Another report from the AP:

Carlyle Capital Reports Additional Margin Calls, Considering 'All Options'

LONDON (AP) -- Lenders to Carlyle Capital Corp. Ltd. have begun to liquidate securities held in its $21.7 billion portfolio and the fund said Friday it was considering "all available options."

The margin calls against Carlyle portend an ominous development one day after the fund was served with default notices, convulsing already skittish markets.

...Carlyle Capital said it received additional margin calls and default notices Thursday from banks that help finance its portfolio of residential mortgage-backed securities. It said it may not be able to meet the increased requirements.

The fund said it was unable to meet margin calls from four banks Thursday, raising fears that its entire portfolio could be unwound. Securities have dropped sharply in recent weeks as banks pull back on their lending, forcing investment vehicles and funds like Carlyle to dump assets.

...If the value of the security held as collateral falls, the lender will ask for more collateral, a "margin call", in order to secure the loan. If the borrower does not meet the margin call by putting up more collateral, the lender may sell the security.

Highly leveraged funds have become increasingly vulnerable because their cash cushions are tiny compared with actual assets. Sudden price moves in the underlying assets can send margins spiraling, quickly depleting a fund's cash.

Source: yahoo.com

We have been so focused on the problems in the mortgage market, that a potential larger problem is still lurking out there. When money was easy to get a lot of hedge funds used this easy money, or leverage, to magnify their market bets.

The great thing about this leverage is that it typically takes very little of your own money to put a lot of other people's money at risk. Now those that had extended credit to the hedge funds are starting to become concerned that the money they lent out is worth less now. So they pick up the phone and ask, nicely, that the borrower put up additional money as a sign of good will.

The borrower or in this case a hedge fund typically runs a tight ship and does not keep a lot of extra cash around for this margin call. So they are forced to sell assets in a down market. I could go on, but basically the cycle of margin calls and selling into a down market continue. As the selling continues it spreads to other market sectors not directly affected by the original problems. This could drag on for months, or we could get lucky and a panic break outs.

We have entered a painful period of de-leveraging. I would prefer a panic over a long period of blood letting. Unfortunately too many people are interested in preventing a panic, so expect loses to continue until they stop.

Source:
http://www.bloomberg.com/apps/news?pid=20601087&sid=aJcGRsXmyltU&refer=home
http://biz.yahoo.com/ap/080307/britain_carlyle_capital.html