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Legg Mason: Does It Add Value?

We continue to look at the ability of the leading mutual fund families to add value. Some of the fund companies we've recently examined include Northern Trust, Oakmark, Fidelity and American.

Today, we look at Legg Mason, which was the 11th largest asset manager in the world at the end of 2010 with $672 billion under management. Legg Mason Capital Management's chairman and chief investment officer is Bill Miller, the legendary manager of the Legg Mason Value Trust (LMVTX). Miller accomplished something even Peter Lynch had never done by outperforming the S&P 500 Index for 15 straight years. Money magazine named Miller "The Greatest Money Manager of the 1990s."

To see if its family of funds has added value, we compared their performances to similar passively managed funds. Using the Morningstar classifications, there are six equity asset classes for which Dimensional Fund Advisors has similar funds.

The table below presents the results for the 10-year period ending April March 2011. Returns were rounded to the nearest tenth, so averages may not match.

Legg Mason's funds managed to underperform in all six asset classes, with the underperformance ranging from 0.9 percent to as much as 3.6 percent. An equally weighted by asset class portfolio of Legg Mason funds underperformed the equally weighted passive portfolio by 2.4 percent. As my Right Financial Plan co-author Kevin Grogan noted, "If this were a fight, it would be stopped."

While at least some investors are aware of the difficulty that active managers have in generating alpha, many aren't aware that research shows that the funds that do manage to outperform tend to do so by relatively small amounts, while those that underperform tend to do so by larger amounts. This is especially true for taxable accounts. Thus, the risk-adjusted odds against outperformance are very high. The evidence on Legg Mason's performance is consistent with the historical evidence.

The question I have is: Why does Legg Mason still manage almost $700 billion in assets? In a triumph of hope, hype, marketing and a belief in the past performance of active managers as a predictor of future performance, investors have been leaving billions of dollars a year on the table in their quest for the Holy Grail.

What explains this behavior? Are investors impervious to poor performance? Are they willfully blind to results? Is the truth so painful that the mind doesn't want to face it, so the fantasy survives? Or is it that investors have a very difficult time admitting the errors of their ways? Thus, they cling to the hope that Legg Mason's performance will turn around.
Wes Wellington, vice president at Dimensional Fund Advisors, offered this explanation: "Miller is clearly very smart, very well-read and is catnip to journalists who seek out money managers with a knack for thinking outside the box and expressing it thoughtfully. It's hard to imagine anyone being unimpressed by his intellect and the breadth of his reading list. As a result, for the overwhelming majority of investors, it's all but impossible to accept the notion that someone of such erudition can't outperform a simple market index, and even a sustained period of underperformance is chalked up to bad luck that will be corrected in the next cycle."

More on MoneyWatch:
Oakmark: Does It Add Value? Fidelity: Does It Add Value? John Hancock: Does It Add Value? Merrill Lynch Clients Stay Despite Not Trusting the Firm How Misleading Maturities Make Bond Funds Riskier
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