Given the battering print publishers and shopping malls are taking courtesy of the internet, who would make big bets on these beaten-up fields of commerce? Famed stock picker Bill Miller and his 36-year-old son Bill Miller IV would. They’re co-managers of Miller Value Partners’ Income Strategy investment fund.
In their quest to invest in unconventional income sources, the contrarian Millers buy undervalued securities with a history of high levels of income, the younger Miller explains in an interview with ThinkAdvisor. He also reveals his father’s investing process.
Seventy percent in equities — mainly private equity stocks — the income strategy is scoring a total net return of 16.26% on a trailing 12-month basis. AUM is $120 million.
Investing legend Miller, 67, founded Miller Value Partners after a 35-year career at Legg Mason Capital Management. He served as chief investment officer there and became a Wall Street star managing the Value Trust fund and outperforming the S&P for 15 years straight, from 1991 to 2005. But during the financial crisis, he misjudged the market, figuring that once the calamity subsided, financial stocks would quickly rebound, son Bill says.
The manager was proven wrong, however; and his fund lost two-thirds of its value. Following some years of gains and losses running another fund, Miller departed the firm in 2016.
Bill IV joined Legg Mason in 2008, working with his father primarily in a research capacity. A year later the two started the Income strategy and by 2013, he had become co-manager.
The number of holdings in the portfolio is small; but when it comes to variety, it is extensive and includes high-yield corporate debt, preferred shares, real estate investment trusts and business development companies, among others.
Nearly 22% of the portfolio is in the REIT sector. In Q2 of this year, the Millers bought shopping center REITs Washington Prime Group and CBL & Associates.
ThinkAdvisor recently interviewed the Baltimore-based Miller IV by phone. He discussed the managers’ buy-and-hold value strategy — including why investing in alternative asset managers is appealing — and what he’s learned about investing from a legendary fund manager who happens to be his dad. Here are highlights:
THINKADVISOR: There are only 40 names in your fund. Comparatively speaking, that’s very few.
BILLL MILLER IV: Yes, relative to other portfolios, it’s super-concentrated. Most income funds have 100-plus names. Ours is a very concentrated, aggressive income fund.
Also, surprisingly, about 70% of the holdings are in equities versus bonds. And you’re mainly in private equity stocks.
Those are the biggest positions, collectively, about 15% of the fund. When we started, we had the exact opposite: 70% in bonds. Now we think the best risk-adjusted income streams are in equities, broadly speaking.
You started the fund with your father in 2009 when you were both at Legg Mason Capital Management. What did you have in mind?
Undervalued income was the idea then, and it still is today. We said let’s start a portfolio of things that are safer in the capital structure but that could do equal to or better than equities and that, even if spreads didn’t recover that year, we could [get] a very nice income stream in the interim.
A recent Forbes article called your father “an aggressive risk-taker” and your style “more cautious.” True?
My father has a lower evidentiary threshold than I might. That’s more a function of his experience: He’s able to see patterns and understand their significance more quickly.
And the implications of that?
If he sees a pattern that he believes has a lot of signal value, he may be more willing to act on it a lot more quickly that I would. I might see the same fact pattern and say, “I want to look at a few more things before I commit to it.” He’ll say, “I’ve already seen this story enough times, and I don’t need any more information. This is enough to be a good setup.”
Is that what he thought about Bitcoin when he reportedly invested 1% of his net worth in it?
He put 1% in many, many years ago. Now it would be a more significant portion of his net worth.
Do you have a number?
I prefer not to say, but it’s significant. We both invested in it early on. It’s been a good ride.
What have you learned most from your dad about investing?
Observing him operate has been very valuable. For him, everything comes down to an objective assessment of the facts. He’s very unemotional, unreactive and data-driven. Often in the market, you make a lot more money sitting still than by being active and making a lot of changes to the portfolio. So watching his approach to valuation and looking at situations has been extremely valuable.
What else about his process has been helpful to you?
One of the reasons he’s done as well as he has is because he brings a philosophical approach to his analyses. He can view things from angles that no one else is looking at. That’s allowed him to be much earlier into all kinds of huge compounding machines that other people are afraid to step into before they’ve seen the proof. After the market has seen the proof, a lot of the time it’s too late.
What was your father’s big investing mistake during the financial crisis?
He would say that his mistake was that he viewed the financial crisis from a typical financial crisis perspective, which is that once you inject liquidity, things tend to get better — except this wasn’t a typical financial crisis. This was a crisis of collateral values which underpinned the entire system. That’s what he’d tell you he missed.
What lesson did you learn from that?
His framing on the collateral values is something we think about often to this day. It’s been an important takeaway.
When it comes to the income fund, why do you like investing in alternative asset managers, such as the Carlyle Group and Apollo Global Management, your top two holdings?
They had a great year, broadly, up 40% to 60%. But we think the valuations are compelling and that they could continue to move meaningfully higher. They check all the boxes for a great investment, like huge insider ownership, very smart investors, great capital allocation. They’re trading at very low multiples relative to what we think they could earn over the next couple of years. They’re also gathering assets much faster than traditional asset managers.
The fund is focused on REITs to a large extent. They’re 21.60% of the portfolio. Why is that?
We have the flexibility to buy anything we think is producing compelling valuation. So REITs are absolutely on our radar screen. But we also invest in business development companies, publicly traded partnerships, debt. We buy anything with an income stream that we think is potentially attractive.
At a time when many insist that the internet is killing off shopping malls, why are you investing in shopping-center REITs?
Valuations are reflecting expectations that we think aren’t all that likely to come true. There are opportunities to innovate and change the centers to bring traffic, revenues and income.
They’re being redone to meet the needs of consumers in the digital era. New businesses — with things people need that you can’t digitize, like exercise facilities, hair salons, hair-waxing places — are going where those empty [store] spaces were. The dividend yields on some of these REITs are 11% to 13%, while they’re extremely well covered by the cash flows, even if the centers are turning over tenants rapidly. Share occupancy is still [about] 90%.
One of your holdings is New Media Investment Group. They invest in print newspapers! That seems a pretty contrarian bet.
They own community newspapers in a lot of rural areas. The content they create is much less commoditized than content you can get anywhere on the Internet. So if there’s a reporter covering, say, a local zoning meeting, it’s content people are willing to read. New Media’s idea is to buy up a lot of papers that have had a hard time coming into the digital [age] and make them competitive, given the way people are now consuming content.
You also own Valeant Pharmaceuticals International, which has been mired in a fraud-and-kickback scandal. Safe to say that’s a controversial company.
It certainly is. [But] we think the valuation is compelling. We own the debt, so we have a priority claim relative to the equity and the capital structure. We think that the cash flows and asset values more than cover what we own. We’ve done well in that name. The debt has appreciated meaningfully since we bought it.
What impact will rising interest rates have on your fund?
Its best periods of performance have come during times of rising interest rates and increased investor optimism about growth prospects. So, unlike a lot of other income portfolios that have duration risk — that is, as rates rise, you’re likely to see some headwinds in performance — we think we’re poised to do well.
What if rates don’t rise in the near future?
Deflation would be a meaningful risk for this type of strategy. A lot of things we own will do better in a more growth-oriented environment. So if we get any kind of tax reform, for instance, that would be a good thing.
Do you see a market correction on the way?
Corrections are very, very hard to call. So we don’t try to play that game. We look at everything on a bottom-up basis and try to incorporate a variety of macroeconomic scenarios in our name-by-name analyses — what [the security] might be worth in each scenario and try to weigh those scenarios accordingly.
So are you bullish?
We think things will continue to be OK. Most valuations, broadly speaking, look fairly valued to us, though there may be some pockets of high expectations; for example, Tesla. Everything we own in our portfolio looks very inexpensive.
How long do you think “things will continue to be OK”? We’re optimistic about market prospects over the next 5 to 10 years. It’s very hard to make shorter-term trading calls. If you position the portfolio around them, the only thing you can be certain of is increased turnover and expenses for the shareholders.
But you obviously don’t tune out current economic, political and global events.
Of course not. But we’re not taking a top-down view and then whipping the portfolio around. The markets, [as a rule], tend to appreciate over time, especially [with] an income-generating portfolio, where time is very much on your side. The goal over the long term is to outperform dividend yields.
Do you own any international?
Not currently. We’ve bought things abroad in the past, some of which have worked better than others. We need to feel we have a valuation edge or signal that we can’t get somewhere else.
What’s your thinking about master limited partnerships?
We’ve become much more interested in the MLP space over the past six months or so because they’ve not done all that well. Now valuations are at a level where we can get excited. The space is something we’re actively considering.
And your thoughts concerning the active-versus-passive debate and the move to passive investments, like ETFs?
Active managers haven’t earned their fees, in the aggregate, over long periods of time; so that shift makes a lot of sense. The way that incentives have evolved, most managers have the incentive to become closet benchmarkers — closet indexers — because if they underperform by a wide margin, they’ll get fired. That’s their biggest fear, so they end up constructing portfolios that largely look like the index.
Moving on to something else: One of your pastimes is playing poker. Do you ever play with your dad?
Oh, yeah. [But] poker isn’t something that he’s spent a lot of time studying! [laughs]
So you usually win?
That’s a fair statement!
Do you two have any ongoing points of disagreement in managing the Income strategy?
We tend to agree on most things. We’re both constructive about how we offer ideas. I think we tend to see the world in the same way. We’re both data-driven; and if we present a good argument, we try to stick to the facts and logic, and base everything on that.
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