How to make money in a changing market: Bill Miller

One of the most striking changes in the more than 30 years I have been involved in professional investing is the evolution of investment advice and products.

It used to be that a stockbroker’s value came from having something unavailable to the average citizen: access to and knowledge about financial information. Stock prices could only be found on the ticker tape in brokerage offices or the next day in the newspaper. The only sources of company financial information were Value Line and the S&P tear sheets. Today, most financial advisors are asset allocators often using sophisticated software that did not exist 30 years ago.

There are now three full-time networks devoted solely to business and financial news, and stock quotes are ubiquitous. They were on the video in my taxi today, along with up-to-the-minute business news.

Tim Boyle | Bloomberg | Getty Images Bill Miller

Tim Boyle | Bloomberg | Getty Images
Bill Miller

Let’s consider investing’s past for a moment:

—When I got into the investment business in 1982, the entire U.S. equity mutual fund industry had assets of around $45 billion. At year-end 2012, U.S. equity funds assets were nearly $9 trillion!
—At the peak, prior to the financial crisis, the one subsidiary at Legg Mason that I led had more than 70 percent more assets than existed in the entire industry when I joined the firm.
—There were no ETFs in 1982. Today, even most professionals cannot beat an unmanaged index fund. Over the past five years, more than 70 percent of active managers have failed to beat the S&P 500 (which is why indexing and ETFs have had such explosive growth).
—The giant private-equity firms were tiny, such as KKR, founded in 1976; or they did not exist, such as Blackstone, founded in 1985.
—The world’s largest asset manager, Blackrock, with assets exceeding $4 trillion, was only started in 1988.
Hedge funds were few and far between instead of in the papers every day.
—There was no Morningstar back then. In 1984 the idea occurred to Joe Mansueto to create a “Value Line for mutual funds” out of his apartment with $80,000, and today it is a public company and he is a billionaire.

Now let’s accept some things about investing’s future:

ETFs are here to stay, as are hedge funds and alternative investments.

The traditional mutual fund is under long-term secular pressure due to the press of those new products and their mediocre performance.

Profit potential

Finally, let’s figure out how to position your portfolio in a market we can’t predict or control:

  1. One consequence of the financial crisis is extreme risk aversion, evident in near-record-low bond yields. Since the crisis, risky assets, such as stocks, have done better than “safe” assets, such as government bonds. It is my opinion, and it looks likely to continue for many years.
  2. Risk aversion has led many equity mutual fund managers to become closet indexers, as they fear the loss of assets and employment should their returns fall below those of the benchmark. If you go with an active mutual fund, pick a conviction manager who has what the academics call “high active share”—that is, his or her portfolio looks very different from the market.
  3. The institutionalization of the hedge fund industry, such that low volatility is often more important than excess returns—means that the opportunities for truly active managers who think independently and are able to take advantage of the behavioral foibles of others are great, in my opinion.
  4. The very high fees charged by private equity and hedge funds create a significant hurdle to overcome in a low nominal rate-of-return environment. If you are thinking about those products, consider their publicly traded management companies instead.

Some things never change in the investment business. The cycles of greed and fear, of undervaluation and overvaluation, have persisted as long as there have been markets.

The rest, as philosopher Ludwig Wittgenstein wrote about the future of the world, “we always have in mind its being at a place where it would be if it continued to move as we see it moving now. We do not realize that it moves not in a straight line, but in a curve and that its direction changes constantly.”

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