Bill Miller is betting on an economic rebound by stuffing his shareholders' money in downright nasty places, including a fizzled Enron partnership.

Late Monday afternoon Miller, the only fund manager to top the S&P 500 in each of the past 11 years, filed his shareholder report for the $1.7 billion ( LMOPX) Opportunity Trust fund -- a younger, more aggressive portfolio than his index-beating $11.8 billion ( LMVTX) Legg Mason Value Trust.

The upshot: He's expecting the economy and corporate profits to rebound this year, but he thinks already rich valuations will put a lid on returns of around 10% for the major stock averages. So, he's scarfing up the battered shares and bonds of companies that could ride the economy up like Level 3 Communications ( LVLT), Broadwing ( BRW) and AmeriCredit ( ACF) -- though many observers have put these companies on a death watch.

The Opportunity fund, launched at the end of 1999, has topped the S&P 500 in each of the past two years. But this report, in which Miller admits to taking a bath on bonds issued by the bankrupt Exodus Communications and one of Enron's partnerships, should've come with a stiff drink. For market observers, it's another example of Miller's yen for going far from the market's sweet spot -- a strategy that has paid off in the past.

Overall, Miller is bullish on stocks after two straight down years, but he adds that valuations are too high after a fourth-quarter rebound. To aim for higher gains in coming years, he's investing in companies smacked by what he hopes are severe but temporary malaises: the recession, the telecom sector's collapse and the gush of companies with credit problems. That's led him to a gaggle of truly unloved outfits, whose possible demise he doesn't ignore.

"Companies such as Level 3 Communications, Providian ( PVN), Conseco ( CNC) and AmeriCredit should be leveraged beneficiaries in a stronger economy," he writes. "If the economy has a double-dip recession, as some think, we would likely fare quite poorly, since a few of our holdings may not survive under such circumstances."


Bold Enough to Hold
The Opportunity fund's top 10 holdings at year-end were hardly market darlings
Security Percentage of Net Assets
Level 3 Communications 5.7%
AmeriCredit 5.1
Cott Corporation 4
Level 3 Communications bond 3.9
Amazon.com 3.9
Abercrombie & Fitch 3.8
Gateway 3.7
Amazon.com bond 3.6
Enterasys Networks 3.6
UnumProvident 3.5
Source: lmfunds.com.

At the end of last year, troubled telecom outfit Level 3 was the fund's top holding, representing 5.7% of the fund's assets. A further 3.9% of the fund's money was sunk into the company's bonds. Like most upstart telecom shops, Level 3 saw demand and its access to more money dry up, leading some observers to doubt the company will survive this downturn. The stock, added to the fund in last year's third quarter, is down 90% over the past 12 months and 40% since Jan. 1.

In the fourth quarter, Miller started significant positions in another troubled telecom concern, Broadwing, and subprime lender AmeriCredit, the fund's second largest holding at year-end.

Broadwing, down 37% already this year, "is the old Cincinnati Bell married to a new age telecom company," Miller writes. Expecting revenue from the old-line business to fund faster-growing lines like data transmission, Miller believes the company is a prime takeout candidate, worth $18 to $20. The shares were trading at $6 at the close of trading Monday.

In his Value Trust fund, Miller has made similar bets on unloved communications networkers like Corning ( GLW), Tellabs ( TLAB) and Lucent Technologies ( LU).

AmeriCredit lends money to car buyers who have sketchy credit. Like other subprime lenders, the company has come under pressure during this economic downturn, leading Miller to see rosy days ahead if the economy comes back to life. The stock is down 35% since Jan. 1, but Miller expects earnings of $3.75 per share this year and earnings growth north of 20% over the next three years. "We think $60 is a reasonable expectation over that same period," he writes. The stock was trading at $20.65 at the close of trading Monday.

Miller also added to his already big bet on Amazon.com ( AMZN), raising the fund's share balance from some 5.2 million shares to 6.2 million shares in the fourth quarter. Largely thanks to his funds' stakes, Legg Mason is the largest holder of the online retailer's stock and bonds; at the end of last year, more than 7% of the Opportunity fund's assets were invested in Amazon.

Amazon's shares are up 27% so far this year and its bonds were among the fund's top-performing picks in the fourth quarter, rising 33%.

Thanks to the sagging economy and telecom sector, high-yield bonds have limped over the past three years, piquing Miller's interest and earning them a 12% position in the Opportunity fund.

"I regard this asset class as among the most attractive not only now but for the next several years," he writes.

That said, he's not shy about admitting the risks involved. Over the past three years, the average high-yield bond fund averages a nearly 2% annual loss, and Miller admits to making some poor choices. The fund lost money on bonds issued by bankrupt Web site host Exodus Communications and also on debt offered by one of Enron's collapsed partnerships known as Osprey. "It is an educational experience," Miller writes.

The Enron experience hasn't scared him away from private partnerships, though. One of the fund's newest positions is an investment in the Davis Partners Fund. This is a private portfolio managed and mainly owned by the folks behind the Davis Funds, whose price-conscious approach has earned the ( NYVTX) Davis New York Venture and ( SLASX) Selected American funds accolades and billions of dollars. Miller's fund is the only outside investor in the partnership, which is a high-octane version of the Davis mutual funds. In addition to making big bets on the public funds' faves, it also invests in options and private deals.

Miller reminds shareholders that the Opportunity fund "should not be your sole exposure to the equity market" and his eclectic moves illustrate how tough it can be to find opportunities in a market that's ravaged, but not necessarily cheap.

Some might say these picks demonstrate why Miller's frequent comparison to Fidelity guru and Andy Warhol lookalike Peter Lynch are inaccurate. Miller's bets are bolder -- but then, Lynch never came close to matching his index-beating streak either.
Ian McDonald writes daily for TheStreet.com. In keeping with TSC's editorial policy, he doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. He invites you to send your feedback to imcdonald@thestreet.com, but he cannot give specific financial advice.

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