In the name of the fund

I have often argued that Legg Mason Value Trust’s name is misleading. When Bill Miller, the trust’s manager, responded in The Wall Street Journal that I should “confine [my] opinions to things about which [I have] some expertise or training,” I paid attention. After all, Mr. Miller is a leading investment guru, and his Legg Mason Value Trust has beaten the Standard & Poor’s 500 stock index 10 years straight.

Moreover, Mr. Miller’s slight was right on the money. I do lack formal training or experience as a financial analyst or economist – though I have spent the last decade immersed in securities law.

There’s one problem, however. Whether the trust’s name is misleading is a regulatory – not financial – question. And in this area, it’s Mr. Miller whose credentials are lacking.

What’s in a name?

The name of Mr. Miller’s fund is misleading because it doesn’t invest consistently with the most commonly shared definition of “value” – regardless of whether that definition is accurate or exclusive.

Most investors and financial journalists, and, possibly, the majority of financial planners, interpret “value” as referring to stocks with low price-earnings and price-book ratios.

The Value Trust holds many stocks with high p/e and price-book ratios. “The correlation of Legg Mason with the Wilshire Target Large Growth is 0.84 and with Wilshire Large Value is 0.68,” notes Harold Evensky, a principal of Evensky Brown & Katz in Coral Gables, Fla.

In Mr. Miller’s defense, Morningstar managing director Don Phillips says that the fund manager “most certainly is a value investor,” and argues that Mr. Miller “may be truer to the spirit of value investing than those who blindly follow low-p/e screens.”

“Bill Miller is a great value investor,” adds Oakmark Associates’ Bill Nygren.

Other professionals, while recognizing Mr. Miller’s superior investing acumen, are less impressed by his understanding of value investing.

“Almost all academics and practitioners understand the word `value’ to refer to stocks selling at lower ratios of price-book value, earnings, sales or other standard balance sheet measures,” says William Bernstein, author of “The Intelligent Asset Allocator.” “This is also how most ordinary investors understand the word as well.”

Mr. Evensky agrees, remarking, “Mr. Miller is obfuscating reality by playing games with semantics.” He adds, “The use of the term `value’ in the name of the fund is, at best, disingenuous and, at worst, grossly misleading.

“To the investing public [and its advisers], `value investing’ connotes a specific market exposure,” adds Mr. Evensky.

Mr. Miller told The Wall Street Journal that his fund’s definition of value is the one “that’s used in every textbook on investment theory.”

I’m no finance expert, but even to an amateur, Mr. Miller’s “textbook” definition of “value investing” appears to make a mockery of the idea of investment style.

Mr. Miller’s prospectus says that the trust “follows the value discipline in selecting securities and therefore seeks to purchase securities at large discounts to the adviser’s assessment of their intrinsic value.”

“Who can argue with a manager looking for securities he or she believes are cheap compared to the current market value?” Mr. Evensky quips. “In fact, I’d be mighty concerned about a manager whose strategy was based on buying overpriced positions.”

Mr. Miller says that shareholders “look at the prospectus and see what we say about value in there and how we assess it.” Again, right on the money. Investors shouldn’t judge a fund by its name and should always consult the prospectus before investing.

But regulators and fund companies need to live in the world of how investors actually behave, not how they should behave.

The SEC’s own studies have shown that the prospectus is a little-used resource in making decisions for investments. Fund names, however, show up in every resource that investors use to pick funds, and accordingly carry independent weight.

Legg Mason presumably chose to include “value” in the trust’s name in order to communicate something about the fund to potential investors. But the way that most investors are likely to interpret the name – that the fund will invest in stocks with low p/e and price-book ratios – is contradicted by the fund’s true investment style.

Should Mr. Miller change his investing style to match his customers’ sophistication level? By no means. Rather, he should change the name of his fund.

Either call it the Legg Mason-Value-as-Defined-by-Bill Miller Trust or simply remove “value” from the name.

Or he should require that shareholders submit some evidence of graduate work in economics as a condition of buying fund shares.

I Say Tomato …

The problem created by the name of the Legg Mason Value Trust permeates much of fund regulation – and business relationships.

It’s a communication problem, in that it arises when a speaker fails to account for the way his listeners will interpret his statements.

The fund prospectus – where Mr. Miller expects investors to learn his definition of “value” – is a good illustration. Three years ago, the SEC conducted a major overhaul of fund prospectuses, which Arthur Levitt, then its chairman, promised would make them “simpler, clearer, more useful and, we hope, more used.”

How did Mr. Levitt do? Paul Roye, director of the SEC’s division of investment management, recently noted, “The average shareholder can’t make heads or tails of the prospectus,” according to an industry newsletter called Fund Action.

The fund prospectus still reflects the organizational and substantive logic of a lawyer, not the decision-making process of an investor.

It will never be an effective communication tool until its content is dictated both by the information that investors actually use to make investment decisions and the way they use it.

Nor is investment advice effective if clients don’t understand it. An adviser cannot communicate effectively with a client if he doesn’t know how the client will interpret what he’s saying. Ask a client about his tolerance for risk, and you had better understand what he thinks “risk” is before you act on his answer.

As Mr. Levitt once said, “Disclosure is not disclosure if it doesn’t communicate.”

And fund names are misleading if what they communicate is inconsistent with the way the funds invest.

Mercer Bullard, a former SEC lawyer, is founder and CEO of Fund Democracy, a shareholder advocacy group in Chevy Chase, Md.