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Miller's time

For years pension plans remained skeptical of the hybrid investing approach of Legg Mason's master stock picker. But now they're big believers.

For years pension plans remained skeptical of the hybrid investing approach of Legg Mason's master stock picker. But now they're big believers.

By Jill Andresky Fraser
July 2002
Institutional Investor Magazine

More than two decades ago, a respectable-looking fellow would lurk around the offices of Legg Mason, the Baltimore brokerage firm. "His wife worked for us, and he'd come to pick her up, usually half an hour early," recalls Raymond (Chip) Mason, the company's 65-year-old CEO. (Mason founded a Virginia brokerage in 1962 and merged it with the 71-year-old Legg & Co., a Maryland broker-dealer, in 1970.) "The wife would usually wind up waiting for him, while he'd spend an hour or more just hanging around," reading Standard & Poor's reports and chatting with the firm's brokers and analysts, recalls Mason. "He was working as the treasurer of a local company and studying to get his Ph.D. in philosophy. But it wasn't too hard to see that this guy really loved the market. I tried to convince him to come work for us."

In 1981 he did. Bill Miller signed on as a research analyst, and in April 1982 the firm launched a value equity fund, Legg Mason Value Trust, and named him co-manager, overseeing $1.1 million in assets. In 1990 he became sole portfolio manager of the retail fund, whose assets currently total $11.3 billion. Remarkably, Miller has beaten the S&P 500 index every year for the past 11 years -- a singular achievement that has made Miller's a household name among retail investors.

But while the 52-year-old portfolio manager has impressed the retail crowd, pensions, foundations and endowments have mostly steered clear. One reason: The talented stock picker resists categorization, and institutions tend to prefer a precisely defined investing style. In the late 1990s he became known as a "new value" investor as he loaded up on growth stocks like and AOL Time Warner. Says Dev Clifford, a managing director at Greenwich Associates, a consulting firm, "Institutional investors hire portfolio managers to fit in a box, and it's going to be tough to fit Bill Miller into a box."

Maybe so, but an interesting thing happened in the past few years: Pension plans came on board. Between January 2000 and June 2002, in the midst of a bear market, Miller's institutional funds (three separate-account products: the value equity fund, which is the flagship LMVT portfolio; a midcap portfolio; and an all-cap portfolio) gained $2.16 billion in tax-exempt assets. At the start of 1997, the group's institutional assets totaled just $100 million; today they're up to $6.3 billion.

Last year Legg Mason, a publicly traded company since 1983, also scored impressive institutional gains with
its fixed-income subsidiary, Western Asset Management Co., which picked up $13.8 billion in new accounts and reported total assets of $95 billion (Institutional Investor, May 2002). Along with other subsidiaries, including Batterymarch Financial Management, Brandywine Asset Management and Perigee Investment Counsel, Legg Mason's total assets under management hit $170 billion at the end of 2001, up from
$140 billion in 2000.

But Miller's makeover in the eyes of institutional investors is clearly the most striking development at the firm. After years of excluding him from money manager searches, consultants recently decided to take another look at Miller's investing approach, and many of them liked what they saw.

Ernest Liebre, a managing director at Cambridge Financial Services, a Greenwich, Connecticut­based consulting firm, especially appreciates Miller's access to top corporate managements -- and the fact that Miller himself is accessible to pension fund clients. Says Liebre: "Recently, a client of ours, a big electronics company, came to us because they were nervous about some Value Trust positions -- especially Amazon, AOL, Dell Computer Corp. and Waste Management. They were able to speak to Miller directly. When Miller started talking, he was able to share such a depth of knowledge about the companies. He knows the people at the top."

Eking out gains in a bear market, Miller attracted attention -- and admiration -- among consultants and pension fund executives who had been skeptical of his approach. For the three years ended December 31, 2001, Legg Mason Value Trust gained an average annual 2.20 percent, versus an average annual 1.03 percent loss for the S&P 500. Last year was tough -- LMVT posted a 9.29 percent decline, compared with an 11.9 percent drop for the S&P 500 -- but over a ten-year stretch, the fund returned a robust annual 18.16 percent, versus 12.91 percent for the S&P 500. Through May 31, Value Trust is down again, by 5.29 percent. It is, however, still outperforming the S&P 500's 6.49 percent loss.

"We like companies that are growing as long as they are earning above the cost of capital," says Miller. "If they are earning below the cost of capital, the faster they grow, the faster they destroy value."

At the end of the first quarter of 2002, when he had 32 percent of assets in financial stocks, Miller's top three holdings were UnitedHealth Group, Waste Management and MGIC Investment Corp. Miller sees MGIC, a mortgage insurance provider, as an industry leader with a low cost structure; he is
impressed with UnitedHealth's recent transformation from HMO to health services provider; and he bought shares in beleaguered Waste Management because he likes its executive team and its solid and consistent cash flow.

Whether the Nasdaq composite index is trading at 5,000 or 1,800, Miller won't disqualify a company simply because of its price-earnings multiple. "A low P/E doesn't necessarily mean low risk," he explains.

Miller's two most celebrated stakes, in AOL and Amazon, are way off their highs. AOL, which represents 2.5 percent of Value Trust's portfolio weight, was bought at an average cost of $3.76, versus a recent $15. Miller's Amazon story has been less successful: The stock represents 5.2 percent of the portfolio and was acquired at an average cost of $31.31, versus a recent $17.

Miller made a big bet on Tyco International, first buying the stock in the 20s, in mid-February, then grabbing more as it fell, including 3 million shares in one day in June, at a price of about $10 a share. (Tyco recently traded at $13.70.) Value Trust held 20 million Tyco shares in mid-June. "We think Tyco has the potential to go up about 250 percent," Miller says.

The veteran money manager lists three keys to his fund's long-term success: a valuation approach that focuses on long-term capital appreciation, a relatively low portfolio turnover rate of under 30 percent a year and a very small team of interdisciplinary research analysts. "It's very difficult to beat the S&P 500," Miller emphasizes, "so the more people that get involved in the process, the less likely you are to be able to do it."

"To a large extent it's luck," he adds. "The way the numbers have come together is a fair amount of good fortune."

Lucky or smart, Miller has signed up more and more pension plans like the $1.3 billion San Antonio Fire & Police Pension Fund, which handed Legg Mason a value mandate last year, a first for the Texas plan. Larry Reed, executive director of the fund, reports that he and his colleagues investigated Miller's record over the past five years. "We did a pretty exhaustive search," says Reed.

CEO Mason planted the seeds for Miller's institutional triumph back in the mid-1990s, when his firm embarked on a campaign to diversify its asset base, trying to sign up more pension, foundation and endowment accounts.

In 1996 Mason tapped Kyle Prechtl Legg, who had earlier worked as one of Miller's research analysts (and is married to the grandson of the firm's founder), to direct the firm's drive into the pension world. Her mission: to
win institutional clients to separate accounts whose investment style would be virtually identical to Miller's LMVT retail fund.

"The driving force for us here is the track record that Bill has achieved," Legg notes, "but you can't distinguish yourself with performance alone, because nobody can win absolutely all the time. That's why you've got to distinguish yourself in the quality of service."

With an institutional account minimum of $50 million, up from $10 million in 1996, Legg now administers more than 30 separate accounts with combined assets of more than $6 billion.

Although the 401(k) arena is forbidding territory, the firm is making a push to increase its defined contribution assets, which currently total $3.5 billion.

Says Geoff Bobroff, a money management consultant based in East Greenwich, Rhode Island: "The ability to make it in the defined contribution business ultimately comes down to your pricing model. Breaking into the DC market as a new player is very, very tough. You can make the decision to lose money on this in the short run, but Legg Mason is a public company, and its investors probably wouldn't tolerate that for too long."

These days, though, investors are not complaining. In late June, Legg Mason shares traded at $48.40, 21.6 times fiscal 2002 earnings, compared with an average multiple of 16.4 for money managers. It's a good bet that some of that premium reflects Legg Mason's
recent success in cracking the institutional market.