Samantha McLemore has been Miller’s co-manager at the Legg Mason Opportunity Trust since 2008. He quotes her as saying “volatility is the price you pay for performance.”
As an example, he notes that the active-share percentage -- how much a fund deviates from its benchmark in composition -- in the Legg Mason Opportunity Trust fund is close to 100 percent. “That means my tracking error is also high, and drawdowns can be high as well,” he said.
But Miller, let's face it, is an exceptional stock picker. During the past five years, the fund has beaten the returns of 97 percent of its peers and outpaced the S&P 500 by an average of more than 4 percentage points annually in the same period.
No. 4. Job preservation is the reason for closet indexing
Hugging the benchmark is a form of job preservation. By guaranteeing a fund won’t deviate too far from the market, the manager gets to keep his job, even with mediocre performance. Closet indexing is a tribute to John Maynard Keynes' famous observation that “Worldly wisdom teaches that it is better for reputation to fail conventionally than to succeed unconventionally.”
No. 5. We are only half way through the shift from active to passive
Miller estimates that when the dust settles, about 70 percent of equity assets will be in some form of passive investment. Given that passive beats active net of fees most of the time, this move makes complete sense.
The bottom line, as Miller sees it, is that the shift from active to passive hasn't been properly framed. It is simply switching from expensive passive investing to inexpensive passive investing.
This article was provided by Bloomberg.