A fund genius who’s overpriced

By Tim Middleton

The value-heavy Dow Jones Industrial Average (INDU) is flirting with a record high, yet Bill Miller's Legg Mason Value Trust (LMVTX) is down 3.6% this year as of Sept. 27 -- about 18 percentage points behind the Dow.

Beating the Dow is Miller's claim to fame, a big reason his fund has swelled to nearly $19 billion in assets. Now he's about to lag the big index for the first calendar year since 1991. So is it time to flee this famous fund?

Well, not for this year's lag. Miller makes big wagers on risky stocks; temporary setbacks are routine.

The reason to bail out of this fund is that it ain't what it's cracked up to be. Yes, it has an outstanding record, delivering annualized returns of 8% over the past five years. But you can do better.

A better opportunity

Don't take my word for it: Follow Bill Miller's example. He created Legg Mason Opportunity Trust (LMOPX) "specifically for his own money," notes Steve Rogé, a financial adviser with R.W. Rogé & Co. in Bohemia, N.Y. Opportunity, which has a much more flexible investing mandate than Value Trust, also performs twice as well: Its annualized five-year return is 16.3%.

Flagging performance is just one rap on Value Trust. Another one is that the name is bogus. Rather than a true value fund, which would be prospering in the current market, it's a blend of growth and value, held back currently by heavy bets on technology stocks.

The fund is also too large; it and other Legg Mason money own 20% of Expedia (EXPE, news, msgs), for example. And its expenses are astronomical. Annual expenses on a $10,000 account are $168. Vanguard Value Index (VIVAX) charges $21.

Miller is generally recognized as one of the best stock pickers in the money-management business. His style is to concentrate assets on relatively few names and to own companies for long periods, staking out positions and adding to them when shares are relatively cheap and not selling until they become overvalued.

That leads to low turnover and high tax efficiency. But it also leads to streakiness, long periods when Miller's picks remain unpopular. He underperformed chronically between 1986 and 1991, and intermittently since then.

Four strikes

He's underperforming now for four reasons, as he explains at Legg Mason's Web site. Through a spokeswoman, he declined to be interviewed for this article.

The biggest reason is a string of investments in Internet names that have plunged in this year of market uncertainty. As of Sept. 27 the fund's fifth-largest holding, Amazon.com (AMZN, news, msgs), was down 31.4% this year. Other holdings included Yahoo! (YHOO, news, msgs), down 37.1%, and eBay (EBAY, news, msgs), down 37.3%.

The three other missteps he mentioned are stakes in homebuilders and managed-care companies, both in the market's doghouse, and the absence of energy holdings, a group Miller has avoided.

One of the fund's biggest problems, however, Miller does not seem to recognize. It is the fund's bloat. Including various share classes, it has assets of $18.67 billion. Worse, a total of some $45 billion at Legg Mason is invested in the same 45 or so names, much of it by other managers running cloned portfolios, according to Greg Carlson, the Morningstar analyst who follows the fund.

Miller likewise doesn't acknowledge the grief imposed on his shareholders by the fund's outrageous expense ratio of 1.68%. Nearly 1 percentage point of that amount is used to pay Legg Mason's brokers for selling the fund. That makes what Legg Mason calls the "primary" shares of Value Trust (i.e. the non-institutional shares) effectively into what other load fund companies call C shares.

These are by far the most expensive type of fund shares to own. Class A shares have much lower expenses. Class B shares have high expenses but automatically convert to A shares after seven years or so. The high expenses of C shares never go down.

The fund industry was so embarrassed by B shares in the 2003 fund scandals that some complexes, including industry-leading American Funds, stopped selling them. C shares are worse but, aside from Legg Mason, nobody sells them in bulk, so they haven't caught regulators' eyes.

Legg, left

But if you enjoy being gouged on price and insist on a Miller-managed fund, Legg Mason Opportunity Trust is for you. Says Rogé, "It can invest in limited partnerships and use leverage and short-sell," which is borrowing and selling stocks in the expectation they can be bought back more cheaply in the future. "Whenever we have a bright manager we hold in high regard, we want to give him as much flexibility as possible."

Rogé's firm invests in the institutional class of fund shares, which have an expense ratio of 1.04%. You and I can only buy the primary shares, whose expenses are a drop-dead 2.08%. Like Value Trust, Opportunity Trust is also out of favor currently, down 0.9% so far this year.

Fortunately for Miller, he makes money whether Opportunity Trust goes up or down. He owns 50% of the company that manages it. (Legg Mason owns the other half.) According to the fund's most recent SEC filing, Opportunity Trust paid that management company $33.4 million in fees in 2005.

Opportunity is a middle-capitalization fund. If what you want is big caps, funds that outperform Legg Mason Value Trust in that arena are as common as crooks in Congress. Consider Janus Contrarian (JSVAX), whose annualized gains in the past five years have been 17.2%. Load fund investors should check out Hartford Capital Appreciation A (ITHAX), with annualized five-year returns of 12.8%.

These funds fall into Morningstar's "blend" category, rather than "value," but blend is how Morningstar categorizes Legg Mason Value. If you want true value, the pickings are even easier. Yacktman (YACKX) has delivered five-year returns of 16.0%. On the load front, Hancock Horizon Value A (HHGAX) has returned 14.4%.

Bill Miller is a brilliant investor, and his current underperformance at Legg Mason Value Trust is meaningless. But he's overpriced, and that holds great meaning. The only guy who can retire rich on what you pay an investment manager is the manager. If you want to retire rich yourself, hold on to your own money.

At the time of publication, Tim Middleton didn't own any securities mentioned in this article. Middleton is the author of "The Bond King: Investment Secrets from PIMCO's Bill Gross" and the former mutual-funds columnist of The New York Times.