Legg Mason's flagship Value Trust fund no longer lagging

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The Legg Mason Capital Management Value Trust fund is doing something not seen in years: It's beating the stock market.

Under new manager Sam Peters, the fund is up 27.8 percent in the past 12 months, compared with 20.6 percent for the S&P 500 index.


Could the fund, which famously outperformed the market 15 years in a row before losing its footing, be turning the corner to a fresh winning streak?

"Obviously, you always hope, but it is that old adage — take one day at a time," said Peters, who took over the fund's management a year ago in April.


Many investors first learned about Baltimore-based Legg because of Value Trust and its former star stock-picker, Bill Miller. Year after year, the fund outpaced the market by investing in a few dozen stocks that Miller believed were selling significantly below their true value and had potential for a huge upswing.

"It certainly was the talk of the fund industry," said Jeff Tjornehoj, a senior research analyst with Lipper. "Every year we would get near the end, watching whether the streak was alive or not. It absolutely drew a lot of attention to Legg Mason."

But Miller's 15-year streak ended in 2006, and the fund's performance deteriorated as big bets he made in the financial and housing sectors soured in the 2008 economic crisis.

Investors fled the fund, which now has about $2.3 billion in assets from a peak of $20 billion in 2007. Redemptions continue to dog Value Trust — at a rate Morningstar estimates at $487 million in the prior 12 months — although the pace has slowed.

"It's not over yet," Peters said, "but we're no different than the overall active industry for the most part on flows."

After the stock crash in late 2008, investors abandoned funds with active stock pickers and largely fled to bonds for safety.

"They had this disadvantage of being an equity fund," said Bridget Hughes, associate director of fund research at Morningstar. "At the same time, they had some pretty poor performance and that exacerbates it."

Shrinking assets prompted the company to merge much of the Legg Mason Capital Management unit in Baltimore, which includes the Value Trust fund, into a New York subsidiary this month. Peters' team of 22 remains in Baltimore, but he reports to New York.


The Baltimore team saw other changes in mid-May with the departures of longtime manager Mary Chris Gay, who dealt with clients, and Randy Befumo, head of research. Gay is weighing her options, while Befumo joined a California-based Internet company, Peters said. Stock analyst Jean Yu was promoted to assistant portfolio manager of Value Trust.

Peters arrived at Legg in 2005, following a stint as a portfolio manager at Fidelity Investments in Boston. He started co-managing Value Trust with Miller in November 2010 and replaced him a year and a half later. Miller continues to manage Legg's smaller Opportunity Trust fund in Baltimore.

During a recent interview at Legg's Harbor East headquarters, Peters said he and his mentor Miller are much alike in their outlook, both value-oriented, looking for companies whose stock is trading far below their perceived value.

But there are differences. Say, a manager identifies three stocks as undervalued by the market, with one having a huge upside potential and the other two having attractive growth prospects but not as great, Peters said.

"Bill would tend to gravitate on the really big bet, where my druthers would be to try to mix it up a little bit more in the portfolio construction," adding the other stocks for diversification, he said. "Bill, brilliantly, will get a lot of conviction about a certain path that the markets and world are going to take. I tend to be a little more agnostic."

Analysts note other differences.


A decade ago under Miller, the Value Trust's annual turnover in the portfolio was about 4 percent, meaning it would take 25 years before the fund's holdings had entirely changed, Tjornehoj said. Turnover last year was 40 percent, still much lower than other funds, but now Value Trust's holdings change every 21/2 years, he said.

Value Trust continues to own no more than 50 stocks, fewer than its peers. But if Miller was gung ho on a stock, it could make up 7 percent or more of the fund's portfolio or a single sector could comprise a significant chunk of the fund, Morningstar's Hughes said.

Now, securities are spread across more industries and the largest holdings make up less than 4 percent of the portfolio.

The biggest holding at the end of May was JP Morgan Chase & Co., making up 3.72 percent of the portfolio, followed by Apple Inc. and Ford Motor Co. at about 3.4 percent.

And while some holdings are less conventional, such as Ford or Citigroup Inc., others like JP Morgan and Blackrock Inc. are commonly owned by similar funds, Hughes said.

"Some of that was intentional. Sam Peters wanted to broaden out the portfolio and at the same time be true to the valuation model," Hughes said. "The performance shouldn't be as wild as it was, but whether or not that that evens out to a long-term advantage for investors, it's too early to make that call."


Morningstar gives Value Trust a low single star rating out of a possible five because of its poor performance record over three, five and 10 years. Analysts also rate the fund "neutral."

"We think the fund has been moderated enough. It isn't going to blow investors up like it did in 2008," Hughes said.

That year, while the market dropped 37 percent, Value Trust plunged 55 percent.

At the same time, Hughes said, questions remain about whether Value Trust can win back investors, and how much time Legg will give it before possibly merging it into another fund.

"You'd like to see those redemptions reversed, and that will happen with performance," she said. "One year is not going to be enough for everyone to come back."

The fund's three-year track record puts it in the bottom 25 percent among its peers, according to Morningstar.


Peters acknowledged the challenges and pressures to boost long-term performance. He noted that stocks still scare investors, many of whom remain in fixed-income or bond-like equities.

"There has been a flight to safety bubble," he said. But "people will come back to active stock picking."

Peters believes in cycles, something he learned from his grandmother, his first financial mentor.

He grew up in New Mexico, where his great-great grandfather started a cattle ranch in the late 1880s that is still run by his extended family. "It makes the outback of Australia look lush," said Peters, who turned 44 last week.

His branch of the family gravitated toward the business side, while cousins handle day-to-day operations of the ranch, which spans hundreds of thousands of acres in the Chihuahuan Desert.

Peters' grandmother handled investments, including oil and gas leases on the ranch and elsewhere.


"She just taught me about cycles. Her basic line was, 'No matter what, everything cycles,' " Peters said.

He said he's seen that play out time and again, with investor mood shifting from extreme optimism to deep pessimism and back again. "You learn to bet the other way," he said.

Peters earned an undergraduate degree in economics from the College of William & Mary in 1991 and an MBA from the University of Chicago in 1999. He worked as a financial consultant for a New Mexico brokerage firm and then in 1999 moved to the fund giant Fidelity, where he managed health care and electronics funds. The chance to work with Miller attracted him to Legg, he said.

When announcing Peters as his replacement at Value Trust, Miller commended the younger manager's "steady hand" during the financial crisis.

"There is no upside to panic," said Peters, adding that he focuses on what he can control. "This was another thing I learned from my grandmother: Don't hide from issues and challenges, and find people who do the same thing."