Bill Miller
CEO, Legg Mason Funds Management

I would like to welcome you all to this conference. This conference is designed for you - you are why we are here. We take very seriously our responsibilities to you since you have entrusted us with your money. We understand that if it were not for your trust in us, we would not have a business. At the end of our annual report, we include a statement that we fully believe. We cannot promise to beat the market or even to match the market. But we can promise that nobody will care more about your money and work harder than the team that we have assembled. We hope to be able to continue to demonstrate that to you.

Why are we doing this conference this way? I will illustrate this with a story. Walter Fontana, a professor at the Santa Fe Institute, reminded me once of the power of stories when I was looking at a particularly complex chart of biochemical pathways in the human body. I told him that the chart was difficult to understand. He told me, "No one can really understand this stuff. People understand things by stories." In fact, there is a great line from the poet Muriel Rukeyser: "The world is made, not of atoms, but of stories." We will illustrate a lot of ideas over the next two days with pertinent stories.

The story that best illustrates this conference has the interesting quality of being not topical but true. About 20 years, ago there was a quantitative investment analyst talking to a group of institutional investors. He explained what modern financial theory understood about markets and about the behavior of different asset classes. He talked about risk and return and time horizons and how those things relate to volatility. You have to think about how assets vary and co-vary. He filled the blackboard behind him with alphas and betas and gammas and thetas. Unless you think about investing and construct your portfolios in this way, you are not doing anything that finance would think adds any value.

The Chief Investment Officer of a very large organization asked a question. "We do it differently in our organization, and I'd like to get your input on it. We get our economists together and think about the direction we think the economy will be heading in. Based on our economic forecasts, we then get our strategists together to talk about how to position our assets strategically - how much should we put in stocks versus bonds, etc. After our strategists get done, our sector specialists figure out in which sectors we should be overweight or underweight. Then our industry specialists figure out which industries in those sectors have the best outlook. Then the securities analysts pick the best stocks in those industries. Then our portfolio managers take those lists of stocks and create a portfolio. What do you think of that way of doing it?"

The guy thought about it for a minute and said, "Based on everything that I know, that shouldn't work." The investor replied, "And so far, it hasn't!"

That is the way that the world thinks about investing today. Look at CNBC and how the market research gets reported. They talk about economic forecasts, strategy, and opinions about sectors and stocks. None of this works very well. Why not? People are focused on the wrong things.

This conference is going to focus on process. What is the relationship between process and outcome, inputs and outputs? We want to help you understand how we think about this, and we'd like to help improve the ways in which you think about investing. I brought with me a recent Consilient Observer that Michael Mauboussin wrote about this topic. In this article, he included a few great quotes. Bob Rubin, former Secretary of the Treasury, said, "Any individual decision can be badly thought through, and yet be successful, or exceedingly well thought through but be unsuccessful because the recognized postulate for failure in fact occurs. But over time more thoughtful decision-making will lead to better overall results, and more thoughtful decision making could be encouraged by evaluating decisions on how well they were made rather than on the outcome." David Slansky in "The Theory of Poker" wrote, "Any time you make a bet with the best of it (with the odds in your favor), you have earned something on that bet, whether or not you win that bet. By the same token, whenever you make a bet with the worst of it, you have lost something, whether or not you lose the bet." Finally, Steven Crist, a horseracing expert, once said, "The issue is not which horse in the race is the most likely victor, but which horse or horses are offering odds which exceed their actual chances for victory. This may sound elementary and many players may think that they are following this principle, but very few actually do. Under this mindset, everything but the odds fade from view. There is no such thing as 'liking' a horse to win, only an attractive discrepancy between his chances and his price." That encapsulates what this conference is about.

In our process, we are trying to determine which stocks will add value and we discard the ones that can't. We try to adapt and evolve as the circumstances dictate. There are three things that make us different than other people. First, we have a broad recognition that the market is efficient. It is very difficult to beat the S&P1 over time. The S&P beats about 55% of money managers in any given year. Over a 20 year period, only about 25% of managers beat the market. If you are truly a long-term investor, you have only a one in four chance of beating the market. This is very interesting when you think about it. The S&P includes just about every company that can fight or crawl its way into the market, and they are left to fight it out. This collection beats most money managers most of the time. We try to identify some of the things that allows the S&P to perform this well, and we try to incorporate these things into our process.

Our second differentiator is the diversity of our investment team and the multi-disciplinary nature of our process. We have a lot of people with very different and unusual backgrounds. We try to think about things differently, and we incorporate approaches that other people do not. This helps us in our investing. The problem for investors is that we all think that we are independent in our thinking and decision-making. No one says, "Invest with me because I think in a herd-like, sheep-like manner." But we all read the same magazines, newspapers, news releases and annual reports. It is the goal of the government to make sure that no one has any special information. How do you get different outcomes when everyone has the same inputs? Our diversity lends us different interpretations and thought processes about these inputs.

Our third differentiator is that we are truly value investors. We take both of those terms seriously. We value individual businesses, not just stocks. We try to buy them at large discounts, and we truly invest in them for the long term. We don't trade the portfolio around very much. Our turnover this year in the Value Trust is only 4%. That means that the average holding in the fund is 25 years, which is longer than the fund has been around. This is the lowest turnover we've ever had, and it should not imply that we are just sitting around letting the fund germinate. But we do try to allocate capital to the highest and best returns.

The result of these three distinctions, diversity, efficiency and value, leads us to have portfolios that look and behave differently than those of most other investment managers. They are very tightly focused - we have $24B in the Value Trust and we have only about 32 or 33 names in the portfolio.2 We are very long-term oriented. We build the portfolio on an expected-return basis, not based on how a benchmark is constructed. Our dollars, mine and yours, are invested in those companies that we believe have the highest risk-adjusted return over a long-term time horizon.

I would like to make a few remarks about the speakers that we have assembled for you. We invited a group of speakers who could illustration some of the concepts that I've just discussed. David Nelson is talking about poker and Paul DePodesta is talking about the Oakland Athletics. The point of these speakers is that if you apply these decision-making procedures to disciplines that are apparently unrelated to investing, you can both learn a lot about investing and improve your performance in those other disciplines. With respect to poker, I saw Dave Nelson putting his poker skills to work after our board meeting the other day. After five hours of playing, I found him at the table with a huge pile of chips in front of him. It had to be two or three hundred thousand dollars. If he's doing that well out here in Vegas, we may need to find a new manager for his funds! Of course, he claims that all of those chips were only worth about $100. He may have more to say about this during his presentation.

We have also invited two professors to speak to you, Terry Odean, a behavioral finance theorist, and Brooke Harrington, a professor of sociology at Brown University. We want to get a sense of what these professors know. Terry will tell us about how we invest, and Brooke will talk about how diversity affects outcomes. She has done some great work in this area, and the results are quite different than those you hear in the popular media.

Brian Arthur and Bill Gurley are two tech specialists who will present. Brian told me that he has three separate and independent presentations that he could give here, depending on what Bill Gurley and Jeff Bezos say. I was very impressed by that, but I was much less impressed with the news that Bill Gurley gave me last night. He pretty much said that everything in my portfolio is a short, at least as it related to technology.

Finally, we will hear two company presentations from Mandalay Bay and Amazon.com. Both of these companies illustrate the principles I talked about earlier. Mandalay Bay has bought back half of its stock over the last five or six years, and Amazon.com continues to evolve its business model using great decision-making procedures.