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Bill Miller and Value Trust Case Analysis

Case Facts:
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 By middle 2005, Leg Mason Value Trust managed by Bill had outperformed S&P 500 index for 14 years in a row. This was longest successful run by any fund manager.  The average return on the fund was 14.6% which surpassed the S&P by 3.67% per year.  The value trust only had 36 holdings, 10 of which accounted for 50% of the fund’s assets.  No manager had matched Miller’s consistent index beating record.  Miller’s results were in contradiction to the conventional theory which suggests that it is extremely difficult to beat the market on a sustained basis as it is characterized by high competition, easy entry and informational efficiency.

Problem Statement:
 The Lag Mason Value Trust has been able to outperform the S&P 500 index for 15 consecutive years till 2005. Will the trust to able to consistently deliver similar performance in future?  Should a rational investor buy shares in Value Trust as on middle of 2005?  What can be possible reasons for the exemplary record of the Value Trust?  Can the reasons of the trust’s success can be only attributed to the trading skills and style of Bill Miller or is it sheer luck?

US Mutual Fund Market:
 The mutual fund market in the US has seen exponential growth in the last 30 years. The numbers of mutual funds have increased from 361 to 8,044 in between 1970 to 2005.  By 2004, Mutual fund owned nearly 20% of the outstanding stocks of US companies.  The value of each share was called Net Asset Value (NAV) NAV = (Market Value of fund assets – liabilities) / fund shares outstanding Annual total return = (Change in net asset value + dividends + capital gain distributions)/ NAV (at the beginning of the year)  Annual payments were collected as a percentage of the fund’s total assets and was called expense ratio.  The expense ratio covered the fund’s management fees, administrative costs, and advertising and promotion expense. The expense ratio ranged from 0.2% to 2%.  The expense ratio was regularly deducted from the fund’s NAV thereby reducing the fund’s gross returns.

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Efficient Market Hypothesis:
Security prices accurately reflect available information, and respond rapidly to new information as soon as it becomes available. EMH’s implications for investors and firms:  Since information is reflected in security prices quickly, knowing information when it is released does an investor little good.  Firms should expect to receive fair value for securities that they sell. Firms cannot profit from fooling investors in an efficient market.

Foundation of Market efficiency  Investor Rationality  Independence of events  Arbitrage

Reasons to Think Markets Ought to Be Efficient  Marginal investor determines prices  Smart money dominates trading  Survival of fittest

Different Forms of Market Efficiency  Weak form efficiency: prices incorporate information about past prices  Semi-strong form: incorporate all publicly available information  Strong form: all information, including inside information

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Information Sets

Information Set of Past prices. Information set of publicly available information. All information relevant to the stock.

Challenges to Efficient functioning of the Market  Behavioral Challenge: Independent deviations from rationality o Representatives drawing conclusions from too little data leading to bubbles in the market. o People are too slow in adjusting their beliefs to new information. o The arbitrage effect. Some investors are quicker in selling high and buying low than other investors.  Empirical Challenges o Markets stay irrational for a very long time. o Stock prices adjust slowly to earnings announcements. o Small cap stocks seem to outperform large cap stocks. o High book value to stock prices stock and high E/P stocks outperform growth stocks.  Crashes and Bubbles

Evidence against efficient Market Hypothesis  Seasonality  Small versus large...
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