A Legg Up on the Market


Bill Miller's focus on the long term is key to Legg Mason Value Trust fund's (LMVTX) success, says co-manager Nancy Dennin, who joined him in 2000. The portfolio holds the distinction of being the only fund to outperform the S&P 500-stock index in each of the past 13 years. The fund's management team doesn't see many attractive stocks in the market now, so they're sticking with a few that they feel have favorable outlooks.

For selected Internet companies, including Amazon.com (AMZN) and InterActiveCorp (IACI), the propects are particularly bright, according to Dennin. The fund's team also thinks a few other companies, including Tyco (TYC), will overcome short-term difficulties. Although Value Trust doesn't avoid troubled companies, the managers will give up on holdings, such as Altria Group (MO), if they feel these companies are unlikely to recover from setbacks.

The fund's fine performance record recently won its managers a 2004 S&P/BusinessWeek Excellence in Fund Management Award. The portfolio has been in the top quartile of large-cap blend funds for each of the past 10 years and in the top decile for five of the past 10. It rose 17.4% on average, vs. 9.3% for its peers, for the 10 years through last year.

This year through May 12, the portfolio is down 4.6%, vs. a loss of 0.8% for the S&P 500. Dennin says it's a result of sell-offs in several holdings that had large gains last year. Bill Gerdes of S&P's Fund Advisor spoke recently with Dennin about his strategy. Edited excerpts from their conversation follow:

Q: Which areas of the market now offer the most attractive valuations?

A: Right now, there doesn't seem to be any broad mispricings in the market. Our turnover is currently very low, reflecting this. Because there aren't many opportunities, we have 33 holdings, just below the 35 to 50 holdings we normally have.

Q: What long-term trends are reflected in the current portfolio?

A: We feel the Internet will benefit from a secular shift of bricks-and-mortar businesses to the Internet. Companies like Amazon.com, InterActiveCorp, and eBay (EBAY) are likely to gain from this. We don't have price targets for our holdings, but with nominal GDP likely to grow 4% to 6% this year, companies that can grow 15% are probably worth a lot.

Q: Have there been any recent changes in the composition of the fund?

A: We added to some holdings, such as InterActive, when their stock prices were weak. If we still believe in our investment premise, we'll buy more when the stock price falls. We added to our Tyco holdings when the [former] CEO was indicted because we felt its businesses wouldn't be substantially hurt by that action.

Q: Could you mention a past holding where you no longer believed in the investment premise?

A: We sold Altria Group when they lost a class action in Florida. Typically, when a company loses a class action, others follow, which, in Altria's case, was likely to hurt its long-term value.

Q: What areas of the market are you currently looking at?

A: We believe energy may be undergoing a secular shift as companies there begin to focus on the cost of capital. Unlike in the past, oil companies are now looking to earn more than the cost of their capital. A few people on our staff are looking into whether our initial assessment of this change is correct.

Q: Do you generally consider top-down trends in managing the fund?

A: We look at everything, including the macro environment, but we don't make any macro calls. Today, inflation is a big worry, but 12 months ago, corporate profits and deflation were the main concerns.

Currently, the market seems to have priced in an aggressive period of interest rate tightening, but we think it's unlikely the Federal Reserve will raise rates sharply. We expect equity prices to be up in the high single digits this year.

Q: Why are the fund's returns below the S&P 500-stock index so far this year?

A: Several holdings have sold off after big moves last year. Nextel Communications (NXTL) and Amazon.com are down, but we think they have attractive business models.


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