The Wall Street Journal today reports that Bill Miller has “destroyed” his former reputation “as the era’s greatest mutual-fund manager.” Miller’s downfall is hardly surprising, given the severe bear market this year. Indeed, Miller (who runs Legg Mason Value Trust) has lots of company. Humbled active managers are everywhere these days.
Miller was long thought to belong to a different breed—a super investor, if you will. This, after all, was the man who beat the S&P 500 every calendar year from 1991 to 2005. As the Journal noted, that’s “a streak no other fund manager has come close to matching.”
But now the streak is over and Miller has rejoined the overcrowded ranks of mediocrity. Again citing the Journal story: Miller’s Value Trust has crumbled by 58% over the past year—20 percentage points deeper than the S&P 500’s loss.
An accompanying chart in the article (see below) shows the fund’s entire history relative to the S&P. For quite a long time, an investor who owned Value Trust from the beginning enjoyed serious bragging rights. Year after year, the fund beat the S&P. At the market’s peak in late 2007, an investor who invested $10,000 in Value Trust in 1991 was sitting on nearly $110,000, or about twice as much as you would have had if you owned an S&P 500 index fund over those years.
But the gravy train has ended. In fact, as the chart above shows, a 1991 Value Trust investment is now roughly in line with what you would have earned with an S&P 500 index fund.
Is this all just coincidence? Perhaps, although one could argue that it’s just one more empirical bit of evidence that it’s tough—very tough—to beat the market over the long run. In the short run, of course, anything’s possible, including lots of statistical noise in returns. As such, one might wonder how often the appearance of investment “skill” is merely a temporary fad that’s fated to buckle under the pressures of market efficiency.
To be sure, the market’s not perfectly efficient, especially in the short run. In fact, one can make a persuasive argument that Mr. Market suffers severe bouts of irrationality at times. What’s more, some investors have a talent for exploiting the short-run inefficiency. But over a period of years, bubbles and other so-called anomalies seem to give way to efficiency, or a bias toward efficiency.
No, you can’t prove it, and so the debate about whether active managers add value is endless. But there are clues to consider. A simple one comes from poring over the long-term numbers for mutual funds, which usually reveals that there are precious few managers who beat their benchmark. The usual suspects are to blame, including the relatively high costs of active management and trading and the inevitable risk of making the wrong bet at the wrong time, which is sometimes fatal.
There is a certain logic to the idea that few, if any, investors can beat the market over time. For the same reason that small companies can’t maintain higher earnings growth rates as they become bigger companies, there’s a limit to how many investors can beat the market. Someone’s always earning above-average rates of return, of course, especially when view in a short-term mirror. But it’s tough to keep it up the high-wire act. That’s not surprising. In fact, it’s more or less fate, as Bill Sharpe explained years ago in The Arithmetic of Active Management. As he explained, “Properly measured, the average actively managed dollar must underperform the average passively managed dollar, net of costs. Empirical analyses that appear to refute this principle are guilty of improper measurement.”
Yes, any one manager can post radically different results relative to the average performance of active managers or the market. That includes radically poor results as well as spectacular gains. Over time, however, the pressure for keeping everyone’s returns average, at best, is powerful. Active management is based on the notion that an investor can escape this fate. Yes, some manage this Houdini act quite well, or so it appears. But it’s a tiny minority, and even then one always has to wonder if the genius du jour is living on borrowed time.