Market Efficiency Bill Miller and Value Trust代写
Market Efficiency
Bill Miller and Value Trust
Module 3: Bill Miller and Value Trust
“Case 2” in textbook by Bruner, Eades and Schill  6th or 7th Editions
This is an individual effort where each student will prepare a written submission for the case @ 40%.
Length: Maximum of 1,500 words.
Five weeks to complete the individual project.
There will be preset questions and formal presentations for tutorial discussions in Week 10, 11 and 12.
Tutorial 13 will be run as informal workshops where you will have the opportunity to ask your tutor on a one-to-one basis “clarifying” questions relating to the case.
Due date: 5 pm, Friday, Week 14
Electronic submission on Blackboard only.
Must be in doc/docx. No pdfs.
IMPORTANT REMINDER:
We are expecting only critical analysis in your work 
Back up your claims with academic evidence/findings
Plagiarism will be dealt with very seriously
Case Requirement


Blackboard
Check out the case requirement sheet in the folder “Assessment” >> “Case 3_Bill Miller”
1. Bill Miller’s Value Trust
Bill Miller’s Value Trust
Longest fund return run in the world (so far)!
The only equity fund to have outperformed the S&P500 for each of the 15 years from 1991-2005.
The fund’s 1-, 5-, and 10-year average annual return up to 2003 were 43.0%, 8.2%, and 16.5% respectively.
The S&P500 1-, 5- ,and 10-year average annual return up to 2003 were 24.4%, 1.0%, and 10.1% respectively.



Long streaks are, and must be, a matter of extraordinary luck imposed on great skill.
  Stephen Jay Gould

Bill Miller’s Value Trust vs S&P500
(1991-2013)
Bill Miller’s Value Trust vs S&P500 vs Buffet’s BRK-A (1991-2013)


2. Bill Miller’s Profile
Who is Bill Miller?
Lead Investment Manager of Value Trust since 31-Dec-90.
Born: 1950
Employment:
Started investing when he was 9 years old
Bought first stock when he was 16
Director of Research of Legg Mason Capital Management from 1981-1985
CIO of LMCM until 2012
On the Board of Trustees at the Santa Fe Institute, a leading centre for multidisciplinary research in complex systems theory.
Education:
Economics honours degree from Washington & Lee University in 1972
Served as a military intelligence officer overseas
Pursued graduate studies in the Ph.D. program in philosophy at The Johns Hopkins University
CFA in 1986.
Bill Miller: The Legend
Ranked among the top 30 most influential people in investing
SmartMoney named him as a member of the "Power 30”
Money magazine named him as "The Greatest Money Manager of the 1990s"
Business Week called him one of the “Heroes of Value Investing”
Named Morningstar’s 1998 “Domestic Equity Manager of the Year”
Morningstar.com selected him as the “Domestic Equity Fund Manager of the Decade” in 1999
Barron included him in its “All-Century Investment Team”
3. End of Winning Streak and Miller’s Response
End of Winning Streak
The end of the winning streak was in 2006.

Performance has subsequently skydived
But rebound in 2011. As of 30 June 2011, NAV of Legg Mason was $9.7 billion.
See this clip from the “Big Short” featuring Bill Miller’s character (Set in March 2008):
https://www.youtube.com/watch?v=JMLurj-nBFs
*Recommended to watch the full movie if you haven’t already.

Miller’s Response (Letter to Shareholders, July 2008)
In his quarterly letter to Shareholder, Bill Miller explained to fund shareholders why his legendary performance has gone to the dogs.

The short version:
The market has gone temporarily insane!
The relationship between price and value has been disturbed (market irrationality?).
Miller’s Response
Here's the long version:

“A group of us were standing around a few weeks ago when Warren Buffett wandered over. Chris Davis had dubbed us the Value Support Group, as we all adhered to that approach to investing. We were commiserating over how badly we had done in this market, how valuation appeared not to matter and had not for the past couple of years, how it was all about momentum and trend, and how we were all losing clients and assets over and above our losses in the market. It seemed like we needed a 12-step program to cure us of our addiction to buying beaten-up stocks trading at large discounts to our assessment of their intrinsic value.”
Miller’s Response (cont’d)


“The best time to buy our funds or to open an account with us has always been when we've had dismal performance, and the worst time has always been after a long run of excess returns. Yet we (and everyone else) get the most inflows and the most interest AFTER we've done well, and the most redemptions and client terminations AFTER we've done poorly. It will always be so, because that is the way people behave.”
Miller’s Response (cont’d)
He has NO plans to change tack just because he's had one bad year – he has stuck with his strategy of investing in financials and over-priced tech stocks.

"I got asked, 'How do you go about analysing your mistakes?' "Miller says. "I said, 'I don't. I don't analyse my mistakes.' We will analyse spectacular errors, but not garden variety errors.“

Prospect Theory (Kahneman, 1979)? Miller is not flexible. Miller wants to dictate to the market how it should go and he stubbornly holds on too long to his losers.
Miller’s Response (cont’d)
Does Miller suffer from confirmation bias?
The tendency of decision-makers to seek out information that reinforces their views of the world and to reject information that challenges those views.
This is particularly common among investors who have been successful in the past. They think that they have figured out a winning formula and when it stops working, they blame everyone but themselves.

4. Market Efficiency
Efficient Market Hypothesis (EMH)
“Random Walk (Malkiel, 1973)”
A stock price is always “fair” or reflect the fundamental value of the company as price reacts to news (information) instantaneously and on average, without bias. Consequently, there is no reason to believe that prices are too high (overpriced) or too  low (underpriced)
Stock price changes are unpredictable as no one knows tomorrow’s news >> ie. Price is a “random walk”
Thus, no one can consistently earn abnormal profits

3 versions of the EMH (Fama, 1970)
Different kinds of information in each form:
Current price fully incorporates information contained in the past history of prices only
Current price fully incorporates all publicly available information
Current price fully incorporates all existing information, both public and private
Management and analysts are not able to profit from inside information
The rationale is that the market anticipates, in an unbiased manner, future developments and therefore the stock price may have incorporated the information and evaluated in much more objective and informative way than the insiders (No empirical results to support this)
What makes the Market Efficient?
Supply and demand pressures
If it is not efficient, investors will trade to profit from inefficiencies

Grossman and Stiglitz paradox
If it is already efficient, no one will expend resources to obtain information and trade (ie. Produce information), then prices would reflect no information and it would be profitable to produce information (Grossman and Stiglitz,1980) à “equilibrium degree of disequilibrium”


Grossman, S. J., & Stiglitz, J. E. (1980). On the impossibility of informationally efficient markets. The American economic review, 70(3), 393-408.
Reasons why the market cannot be fully efficient
Behavioural economics (Shiller, 2014):
“A key Keynesian idea (Keynes, 1936) is that the valuation of long-term speculative assets is … with judgments of facial beauty. Whatever price people generally have come to accept as the conventional value, and that is embedded in the collective consciousness, will stick as the true value for a long time, even if the actual returns fail for some time to live up to expectations.”
“Ordinary investors are somewhat unpredictable and their erratic behavior could cause price changes that might produce losses in the market for the smart money (fund managers) if they invest too much in it.”

Shiller, Robert J. "Speculative asset prices." The American Economic Review 104.6 (2014): 1486.


Limits to arbitrage (Shleifer and Vishny, 1997):
Arbitrage is like a “maintenance tool” for efficient markets, since it is through the arbitrage process that fundamental values are kept aligned with market prices.
In practice, arbitraging is not riskfree, and thus there are limits to the effectiveness of arbitrage in eliminating certain security mispricings.
What does arbitrage mean?
(Watch this short clip from “The Big Short” movie: https://www.youtube.com/watch?v=Cxjdj5_5yNM)
What are the costs and risks for arbitrageurs?
E.g. Implementation costs, fundamental risks, noise trader risks
https://www.youtube.com/watch?v=yLvZKxF43tQ 


Shleifer, A., & Vishny, R. W. (1997). The limits of arbitrage. The Journal of Finance, 52(1), 35-55.


5. Passive vs. Active Fund Management
Passive vs. Active Fund Managers
A passive fund portfolio:
Always holds every security from the market, with each represented in the same manner as in the market: Indexing.
Buy and hold/long term investment strategy
An active fund portfolio:
Provide investors with customised well-diversified portfolios
Usually act on perceptions of mispricing, and because these perceptions change relatively frequently, such managers tend to trade fairly frequently.
It is the result of a thoughtful process!

Can active funds outperform passive funds? Should we invest actively or passively?

One of the most heated debates in INVESTMENTS.
To answer:
Market efficiency debate in the previous section
Quantify risk-adjusted abnormal returns à Jensen’s alpha
How do you interpret alpha? Skill vs luck debate







Zero Sum Game
where Alphai is fund i abnormal return:
  Alphai = ri – rPassive
and
ri   = return of fund i.
rPassive   = return on a passive alternative to fund i.
“Alpha” is purely relative – it measures the rate of return of an active fund relative to its passive alternative.
The alternative portfolio can either be a suitable passive index (S&P500) or the market model or other benchmark models:
  rPassive = rf + βetai*(rM - rf).

So, can individual fund managers
add value?
The answer to this question is a resounding YES:
  Alphai > 0 is possible!
It is perfectly possible for a minority of active managers to consistently beat their passive benchmarks, even after accounting for costs.
However, investment returns combine SKILL and LUCK and it is impossible to separate these.
Of the two, LUCK is the more significant over the short term.
Successful investors may simply be the survivors of a largely random process.
Hence, chance and survivorship make it hard to equate ‘success’ with a thoughtful process.

Outcomes Combine a Skill and Luck
Distribution
6. Bill Miller: Skill and Luck
Miller: Skill and Luck
In his January 2005 letter to investors, Miller said:
  “if beating the market were purely random, like tossing a coin, the odds of beating the S&P 500 for 15 consecutive years would be the same as the odds of tossing heads 15 times in a row.”
Using the actual probabilities of beating the market in each of the years from 1991 to 2005, he put his odds at 1 in 2.3 million.

"So there was probably some skill involved,“ Miller said. "On the other hand, something with odds of 1 in 2.3 million happens to about 130 people per day in the US, so you never know."


Miller: Skill and Luck (cont’d)
However, this analysis would underestimate the odds as many fund managers would not be around after 15 years (for various reasons). That is, the observed frequency underestimates the actual chance!
The chance that someone among the 1,000 or so fund managers who started tossing a coin in 1991 has tossed all heads and is still around is much higher, about 3 per cent. This does not sound that improbable any more, does it?

Source: http://ftalphaville.ft.com/2011/11/22/756681/randomness-and-the-lost-lesson-of-billmiller/

7. Bill Miller and Investment Philosophy
How does Bill Miller add value?
Bill Miller’s Investment Philosophy
(www.lmcm.com)
Value Investing Strategy
Buy beaten-up stocks trading at large discounts to their intrinsic value à belief in reversion to the mean.

”Critics characterize Miller as a growth investor in a value investor's clothing, but a look into his thought process reveals Miller's knack for seeing value where others don't. This ability has allowed the Legg Mason Value Fund to beat the S&P 500 for over a dozen consecutive years--a remarkable feat”
Bill Miller and Value Investing
(Cont’d)
“A more recent example of Miller's value/growth mix is his purchase of Google GOOG, a rapidly growing Internet search engine. While many investors shied away from this stock due to valuation concerns, Miller scooped up shares during its IPO. The stock doubled quickly after the company went public ... this purchase was done in classic Bill Miller fashion--investing in a wildly profitable company that few investors understand or appreciate.”

(very different from W. Buffett, who stays away from such stocks)
Concentrated Holdings
A successful portfolio must focus on the best investment ideas and not diversify so heavily that it fails to receive the long-term benefits of those ideas.
Low diversification (bottom up approach)
Low portfolio turnover (low transaction costs)
Long-term focus (value)
Focus on Shareholder Value
Focus on building shareholder value rather than increasing stock price.
Managers create shareholder value when they invest to maximise the present value of long-term free cash flows.
Investments include capital spending, R&D, mergers and acquisitions.
NOT to maximise EPS or share price: short-term focus that results in earnings manipulation/management and price volatility.
If managers builds ‘value’, then eventually the stock price will follow.
Focus on Shareholder Value (Cont’d)
Currently, there is a lively debate over the extent to which capital markets encourage short-sighted decisions by corporate managers à Focus on share price rather than shareholder value.

In the Owner’s Manual for Google’s Shareholders, the company’s founders declared their intent to avoid the “numbers game” in which companies guide and then try to meet Wall Street’s quarterly earnings forecasts, in many cases by “managing” earnings.

Focus on Shareholder Value (Cont’d)
Coca-Cola has stopped issuing quarterly earnings forecasts because management felt that the practice was drawing attention away from its emphasis on long-term strategy.
Gillette, AT&T, and PepsiCo have done much the same.
In such cases, managers say they are trying to attract investors whose primary concern is long-run value creation and not the next quarter’s earnings.
Focus on Good Management
“Management should allocate capital effectively and treat shareholders fairly.”

The longer the time horizon, the more important is the ability of management to skilfully allocate capital.
Long-term investors depend on company’s managers to be good stewards of their capital and either invest it at rates above the cost of capital, or return it to shareholders in the form of dividends and/or share repurchases.
Bill Miller published a succinct directive in an article he wrote for Directors and Boards in 1991.
The Value Trust investment team has continued to engage companies, publish articles, and use its influence to promote the standards of corporate governance.
Open to New Ideas
“We believe that one of our critical competitive advantages is embracing mental models that lie beyond the traditional world of finance and investing.”

Miller looks for investment ideas from various fields to ensure a multidisciplinary curriculum, and is committed to constant learning and improvement.
Books are stacked atop Miller's desk, and he has thousands of volumes at home ranging from the Holy Koran to "Moneyball: The Art of Winning an Unfair Game.“ Other titles include:
“The Flaw of Averages”
“Why We Underestimate Risk in the Face of Uncertainty”
“Your Money and Your Brain”
“How the New Science of Neuroeconomics Can Help Make You Rich”
“The Difference: How the Power of Diversity Creates Better Groups, Firms, Schools, and Societies”
“The Halo Effect... and Eight Other Business Delusions that Deceive Managers”
“Another Day in the Frontal Lobe”
“The Origin of Wealth”
Reputation
Past success gives Bill Miller a following and thus power in the market place.

This power may enable Miller to squeeze brokers for new ideas/information and better prices (at the cost of smaller traders).
Economies of Scale
Institutional investors play a significant role in equity markets.
Institutional investors hold more than 20% of total US equity (in Australia twice as much).
More than 60% of US equity market turnover due to institutional trading.
Their size leads to economies of scale in administration, research and trading.
Information and Speed
Increased sophistication in financial markets.

Access to market intelligence, i.e., information technology and sophisticated internal trading desks:
Provides quick and automatic access to market data (trading flow, etc.).
Automatic program trading allows bundling of trades to reduce transaction costs.
 Market Efficiency Bill Miller and Value Trust代写