Miller vs. Miller: It's a Knockout!

On the heels of a horrific loss during the most recent bear market, Bill Miller's  Legg Mason Value (LMVTX) came roaring back during the stock market rally that began just about a year ago. In fact, between March 9, 2009, and March 8, 2010, it ranked among the very best large-blend funds, doubling in value.

But that result wasn't half as good, literally, as that of  Legg Mason Opportunity (LMOPX), which gained 205% over the same period.

What makes that particular comparison interesting is that Opportunity is also in Miller's care. So what happened over the past year? Is there something inherently special about Opportunity? And what does it mean for the long haul?

Riskier Assets
You can make a lot of generalities about the strong market that began in early March 2009, but one of the most popular ones is this: While much of the stock and bond markets around the world advanced, riskier assets performed best. That includes emerging markets, high-yield bonds, and stocks seemingly on the brink of disaster a year or so ago.

Legg Mason Value and Legg Mason Opportunity exemplified the pattern, and it helps to explain the performance difference between the two funds. While Miller was partial for both funds to stocks whose prices had severely plummeted, Opportunity scooped up those with more-questionable economic fundamentals and balance sheets, at least at the time. Value, for example, bought shunned financials, including  Aflac (AFL),  Capital One Financial (COF), and  Bank of America (BAC). And these performed well for Value; from the March 9, 2009, market bottom through March 8, 2010, Aflac gained nearly 300%, Capital One more than 350%, and Bank of America more than 400%. But in Opportunity, Miller had bought stocks perceived to be on even shakier ground like municipal-bond insurer  Assured Guaranty (AGO). That stock jumped nearly 500% over the same time period. Multiline insurer with exposure to mortgages  Genworth Financial (GNW), one of Opportunity's best-performing stocks over the past year, gained more than 1,500% as its stock price moved from less than $1 to more than $16.

Such examples aren't limited to financials, either. Value has long owned  Amazon.com (AMZN), for example, which gained more than 100% between March 2009 and March 2010. But Opportunity hitched its wagon to more-niche, beaten-down consumer names like  MGM Mirage (MGM) (up nearly 500%) and  Expedia (EXPE) (up about 250%). In Opportunity, Miller also moved into UAL Corporation  and  Delta Air Lines (DAL), which helped returns; Value, though, stayed away from the airlines.

The Courage of Conviction
In many cases, one, two, or three stock examples aren't able to explain so much performance, but there's a difference here. Both funds are quite concentrated.

Value tends to keep between 30 and 50 stocks, with the top one or two positions at times consuming as much as 15% of assets each and regularly representing close to 10%. Over the past year, for example, utility  AES Corporation (AES) has soaked up between 6% and 10% of assets. Its nearly 125% gain between March 2009 and March 2010 has thus had a meaningful effect on performance.

Opportunity is only slightly different. As in Value, Miller generally holds fewer than 50 stocks. But its individual position sizes rarely exceed 10%. Still, with mid- to upper-single-digit weights in big winners like Assured Guaranty and  XL Capital  (up almost 600%), fewer individual picks can have a big impact.

A More Flexible Miller
Clearly Miller's specific picks made the difference here, but how did Miller choose which fund would get which picks? The bottom line is that Opportunity is fashioned as a more flexible vehicle. Neither hews to its S&P 500 Index benchmark, but Opportunity isn't limited by asset class--it also owned a few private placements last year--and is more likely to move down the market-cap ladder.

So while Miller followed the same plan of attack in positioning the fund for a market recovery--taking a page from 2003's rally, he foraged among the worst-hit stocks--that meant smaller names for Opportunity. Even though there is some overlap in the two portfolios--both own AES and  Eastman Kodak , for example--the difference in the funds' average market caps is meaningful. Value's sits at $31 billion, while Opportunity's rests at just $6 billion. In a rally when small caps outdid large caps, Opportunity's flexibility proved another tailwind.

Opportunity has also been more flexible on the investment-style front, with portfolios historically moving back and forth across the Morningstar Style Box. During its 10-year lifetime, Miller has been in and out of variety of sectors, as well. He's done so on Value, too, but the moves have been magnified in Opportunity.

Miller's Legg Mason Capital Management Charges at a Glance

The Road to Redemption Is Long
Opportunity has decidedly been the riskier option over the long haul. Consider its standard deviation over the past five years: greater than 30, versus Value's 23. Still, neither fund should be considered tame. Indeed, the risks of Miller's high-conviction approach were on display during the most recent bear market--Opportunity lost 65% in 2008; Value lost 55%.

Those results have taken a toll on the funds' long-term returns. Even with the spectacular results of the past year or so, both funds are still in the red for the past five years. (Value's 10-year number is still negative; Opportunity's is in the black but still ranks behind the majority of its mid-value peers, though ahead of the S&P 500 Index.)

Clearly both funds are bold, aggressive options appropriate only for long-term investors with a tolerance for performance swings. Neither should represent the bulk of investors' portfolios, though.