Bill Miller is us­ing earth­quake fore­cast­ing to pre­dict the stock mar­ket’s next Big One

▶ He’s us­ing earth­quake mod­el­ing tools to fore­cast mar­ket risk ▶ “I’m sur­prised some­body is still mess­ing with that stuff”

Bloomberg Businessweek (Asia) - - CONTENTS -

When pitch­ing in­vestors, you nor­mally don’t want “hedge fund” and “earth­quake” in the same sen­tence. But Bill Miller, a once-dom­i­nant money man­ager known for quirky think­ing, is start­ing a fund that will make bets based in part on a com­puter model de­signed to pre­dict nat­u­ral dis­as­ters.

Called Seis­mic Value Part­ners 1, the fund marks Miller’s first foray into hedge funds af­ter decades man­ag­ing mu­tual funds at Legg Ma­son. He won ap­proval last month from the Se­cu­ri­ties and Ex­change Com­mis­sion to open Miller Value Part­ners, a money man­age­ment firm that will over­see his hedge funds. As of a De­cem­ber SEC fil­ing, no money had been raised for the ini­tial Seis­mic fund.

Miller has li­censed a com­puter model from Open­Haz­ards Group, a Davis, Calif., com­pany run by en­gi­neers, math­e­ma­ti­cians, sci­en­tists, and busi­ness ex­ec­u­tives. The idea is to ap­ply the math­e­mat­ics of fore­cast­ing the prob­a­bil­ity of seis­mic ac­tiv­ity to the chances of a stock mar­ket crash.

Like se­vere drops in the ex­changes, “earth­quakes are ex­treme events,” says Lisa Ra­puano, who helped Miller run the Legg Ma­son Spe­cial In­vest­ment Trust mu­tual fund dur­ing the 1990s. “This has the po­ten­tial to help Bill avoid big mis­takes, which is one of the down­sides of his in­vest­ment style.”

Miller de­clined to com­ment. A decade ago, he was among the best­known and most-ad­mired stock fund man­agers in the world, thanks to an as­ton­ish­ing win­ning streak. His Legg Ma­son Value Trust fund beat the Stan­dard & Poor’s 500-stock in­dex for 15 con­sec­u­tive years, from 1991 through 2005. By 2008, when the cri­sis hit, the fund was heav­ily in­vested in fi­nan­cials. It lost 55 per­cent that year, vs. a 37 per­cent loss for the S&P 500.

The no­tion of sidestep­ping a big loss like that holds an ob­vi­ous ap­peal. But some schol­ars dis­miss the idea of ap­ply­ing an earth­quake model to stock­pick­ing. “I don’t think it has did­dly to do with fi­nan­cial mar­kets,” says Joseph McCauley, a physics pro­fes­sor at the Univer­sity of Hous­ton and au­thor of Dy­nam­ics of Mar­kets: Econo­physics and Fi­nance. “I’m sur­prised some­body is still mess­ing with that stuff.”

Open­Haz­ards Chair­man John Run­dle, a well-known seis­mol­o­gist who teaches physics and ge­ol­ogy at the Univer­sity of Cal­i­for­nia at Davis, has been adapt­ing his the­o­ries on nat­u­ral dis­as­ters and fi­nan­cial mar­kets with help from mem­bers of the Santa Fe In­sti­tute, a non­profit re­search or­ga­ni­za­tion where Miller is chair­man emer­i­tus and the largest donor.

Miller’s fund will use sig­nals from the model to make daily de­ter­mi­na­tions on whether to pur­chase or sell short se­cu­ri­ties that mir­ror the per­for­mance of the U.S. stock mar­ket, such as the SPDR S&P 500 ex­change-traded fund, ac­cord­ing to reg­u­la­tory doc­u­ments. The goal is to out­per­form the S&P 500 over pe­ri­ods of a year or more

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