Legg Mason chief sticks to his guns despite misjudging commodity boom There comes a time when every investment star is forced to consider whether his vision has dimmed due to a profound shift in the world. That time has arrived for Legg Mason Capital Management chairman and chief investment officer Bill Miller, whose record run of 15 consecutive calendar years outperforming the S&P 500 ended in 2006. That, combined with a tough first quarter for the fund and a 2005 in which he only scraped past the S&P 500 due to a late rally, has sparked murmurs that Mr Miller has missed the game-changing rise of emerging markets and the pressure it has on commodity prices. 'What leads to people that used to be very good not being able to outperform is not recognising that the market, or more likely the macro-environment, has undergone a secular change fundamentally changing the character of that market', said Mr Miller, 57. 'That is one of the things we are grappling with now.' The streak, which began when Mr Miller became sole manager of the firm's flagship Value Trust fund in 1990 and saw it return an annual average of 16.2 per cent over the next 15 years, was broken in part because he refused to buy into the idea that commodities were on a long uptrend. He and his brains trust are studying how the investment world has changed with the rise of China, India and Russia and new-found stability in emerging markets. Also, Legg Mason is under 'active consideration' about launching its first global fund. 'So far, the evidence is there are fundamental changes going on that might last decades, even generations,' he said. He will back a global fund only when it becomes 'very clear' to him that emerging markets will continue to grow at a faster pace than the US and Western Europe, with less risk than previously 'because the fundamentals of those countries' fiscal situations and in many cases political situations are more stable than they were'. Mr Miller is not yet convinced that the rise in commodity prices earlier this decade was anything more than 'a long, strong cycle' that peaked last year and is now on a staggered path downwards. What might make him change his mind? Commodity prices would need to stabilise or even rise in real terms despite a slowdown in the global economy, he said, 'and then the second piece of evidence would be if something like oil - the biggest commodity in the world - would make a real all-time high'. Last summer, when oil peaked at US$77.03 in New York trading, it fell slightly short of its all-time high in real terms, which is about US$83. A leading value investor, Mr Miller describes what he does as the 'public version of private equity'. Instead of betting on a company to grow - or in the case of stir fryers, for the market to think it will - he looks for a stock he deems to be undervalued by the market, based on his analysis of what he expects the underlying company's future cash flow will be. Once he finds such a stock, he tucks it away, which demands that he have confidence in a company's fundamentals. He might miss some trends, but more often, he avoids market bubbles. 'We are not punters or traders or guessers or that kind of thing,' he said. 'We are really trying to earn large amounts of money with long-term secular changes.' His current crop of top picks are US large caps, like conglomerate General Electric and insurance giant AIG, which he noted had wide exposure in the mainland. '[Their] long-term underperformance has set up a valuation situation that we last saw in the mid-1990s, when the US and US large caps went on a four, five-year period of significant out performance,' he said. Mr Miller isn't the only investor who thinks that US large caps are undervalued relative to other sectors, in part because he believes that the world's largest economy is likely to motor on, if at a slightly slower pace. But while others avoid these stocks, arguing they are cheap because their prices are not likely to rise anytime soon, he sees opportunities. That cuts straight to the heart of his investment philosophy. 'I think the time to buy things is when they are cheap, not after they go up,' he said. He added: 'The investment paradox is, people always buy what they should have bought five years ago. But five years ago, they didn't buy it because it wasn't doing well. And so they let somebody else make all the money, and then after things get popular and go up a lot, then people think they are OK.' Mr Miller's contrarian streak isn't just a character trait - it is fundamental to his investment success, which he says is 'probably 90 per cent to 95 per cent due' to the ability to exploit 'systematic, behavioural and psychological biases' of most investors. In other words, he pounces when most people panic, since - as a slew of research has shown - investors tend to overreact to fresh information (a trait economists call 'recency bias'). He also capitalises on other investors' tendency towards 'loss aversion', or the fact that the average person feels twice as much pain from a US$1 loss as pleasure from a US$1 gain. Based on these insights, as well as an astute analysis of the market, he currently sees bargains in the US home loan sector, which he opined were overly hammered for 'very lax lending standards over an 18-month period' in just one corner of the industry. 'Look at other sub-prime areas - credit cards and auto lending - firms lending to the exact same people who got mortgages,' he said. 'They are not seeing any increase in delinquencies ... People aren't going to turn in their houses before they stop making credit card payments and car payments.' Based on his firm's December disclosure, it owns an 8.14 per cent stake in Countrywide Financial, the biggest home loan company in the US. Due to regulations, he wouldn't say whether he bought any shares more recently, only that 'what usually happens is when people panic and sell things, we like to buy them'. It was this thinking that led him to take chunks of Amazon.com and Google at a time when net stocks were widely eschewed a few years ago. These picks have returned handsomely for him. According to the December disclosure, he owns a 17.76 per cent stake in Amazon.com. In a two-day period late last month, its shares, which lagged last year, shot up 40.3 per cent after the online retailer announced that its first-quarter profits had doubled. 'Until people's basic human nature changes, these behavioural things will be able to be exploited', he said. And whatever else changes - emerging markets or perhaps even commodities - human behaviour is the only thing that won't, and Mr Miller's star may continue to shine.