Bennett is known for running GAM’s key European long-only and equity long/short funds, which at their peak had combined assets of over €3 billion. During his near 11 year tenure running through 31st August 2009 the GAM European Equity Hedge Fund featured an annualised return of 6.2%, double the return of the MSCI Europe Index, with an annualised standard deviation of 9.9% versus 19.7% for the index. Now Bennett is looking to reproduce that solid form for Gartmore investors with the recent launch of the AlphaGen Pan-European Equity Hedge Fund.
The hedge fund opened 30th June with approximately $20 million in capital from Gartmore and Bennett himself. Since joining Gartmore, Bennett has taken over running several long-only mandates with assets of over €3 billion from key portfolio manager Roger Guy. The Hedge Fund Journal visited Gartmore just hours before the hedge fund began trading and found Bennett in a forthright, if slightly cautious, mood as the clock ticked down towards launch.
“In every respect what we are here to do at Gartmore since I joined in January is a cut and paste of what we did at GAM for 17 years,” Bennett says. “It’s really important that it’s been a team lift out and in a sense a strategy lift out from what we were doing at GAM European Hedge which was a straight long/short large cap pan European equity fund. Our aim really is to mimic that. It is certainly not a market neutral strategy. It has pretty active use of the balance sheet.”
Balance sheet use
By active use of the balance sheet, Bennett doesn’t necessarily mean extensive use of leverage – the prospectus limits gross exposure to 200%. Instead, active means to move exposures around, albeit in a purposeful and controlled manner rather than by rapid chops and changes. “The history at GAM was the exposure moved around.” Bennett says. “I would expect something similar here over the next ten years.”
Bennett’s record over 1999-2009 at GAM shows how he adjusts exposure. During the 2001-02 TMT sell-off gross exposure fell to 16.1% and on a beta-adjusted basis got to 15% net short in late 2001. He achieved this by being short tech, which had the lion’s share of beta, and being long the so-called ‘old economy’. The result was 2.7% and 7.8% gains in 2001 and 2002 during a time when MSCI Europe fell 37.7%. Then from 2002 to 2006, the net long position increased every year (from 12.6% to 116.6%).
Bennett characterises his trading style as “fairly plain vanilla”, but notes it will mix equities, index derivatives and exchange traded funds (ETFs). “It will be mainly individual stock positions both long and short, and occasional sector ETFs,” he says. “Very occasionally we will use index options most likely for hedging purposes. That’s less expressing a view targeting alpha and more protecting net asset value. We will protect NAV through a mixture of gross and/or net exposure being trimmed or even collapsed through shorting index futures or buying puts.”
The record with GAM shows Bennett adjusts market exposure in different sectors to take account of cyclical features in the economy and markets. It also demonstrates a parallel aim to offset sectors against each other on the long and short side of the portfolio. “I’m not a believer in a market neutral approach,” he says. “I’m not a believer in pair trades. I’ve always seen both sides of my book as two grosses. I’m a great believer in two grosses instead of the net. With our track record in long-only and hedge we’ve got a history in sector themes. That’s something we did at GAM and that is something we are doing at Gartmore.”
He adds: “You can see it in our long-only funds. They are expressing very clear sector themes right now in terms of over weights and under weights. In the hedge fund it is a case of what you are long and what you are short. For example, I have been underweight utilities for three years. This fund starts off short utilities. That is the kind of investor I am and we are. I don’t run a hedge fund to be worried about the next month. A lot of our views are expressed and implemented with really quite a long duration.”
The case for being short utilities relates to their high balance sheet leverage and the likelihood of tax measures to help staunch the yawning deficits of eurozone governments. In Spain, for example, government policy has suppressed unit price increases for several years, while the cost of energy production has increased faster than the ability of utilities to reclaim it on bills sent to customers. There and elsewhere higher taxes, including possible windfall taxes, changes to regulatory pricing structures, and an unfavourable economic environment for price increases, all auger against the investment prospects for utilities.
Though Bennett is cold on models and quantitative driven investment programmes, he does use sector rotation. He describes the approach as partly quantitative, partly qualitative. “The quantitative side for us is that I look at 30 year trend price/earnings ratios,” Bennett says. “I’m looking for sectors that have multiple years of re-rating or de-rating. That is not a particularly sophisticated model but it is a nice, simple, easy to understand picture. A great example of this was tech,” he says, adding that he finds mean reversion to be a useful investment tool. “The longer the party and the bigger the re-rating then the bigger the de-rating tends to become when it happens,” Bennett says. “Ten years ago you wanted to buy mining and sell tech. Today I think it is the inverse of that. Miners are now on super normal profitability. As soon as any sector or company gets to super normal profitability the sell side and the buy side scramble to justify it with new paradigm nonsense. Now I think we have that with mining, the China miracle and so forth. “
He notes that 10 years ago mining stocks sold at seven times earnings and there was fear that profitability would continue to contract. Now, with 35% operating profit margins, miners make up a big part of the FTSE 100 Index and some analysts believe that a major structural change is underway. “I think that is what is brilliant about our business,” Bennett adds. “Tech was a new paradigm 10 years ago and three years ago people said never bring me a tech stock. Then they became value stocks. That’s not a model, it’s just the market’s behaviour and it does repeat itself.”
Bennett bristles at consultant speak about fund style labels. However, he admits to liking ‘value’, but notes that since 2007 it has migrated to what are usually regarded as growth stocks and away from the traditional value sectors. Bennett began underweighting banks in his long only funds in 2006 and moved to actively shorting them in the hedge fund in 2007. He is still negative on financials generally but given their volatile, warrant-like price behaviour and various bans on short-selling, the hedge fund is avoiding going short. His critique of all three sectors is eerily similar.
Value sectors morphed on leverage
“The traditional value sectors – banks, utilities, real estate – morphed from really quite long term stable businesses to sexy,” Bennett says. “Banks used to struggle to make 5% return on equity. Lloyds was the darling in the UK because they were doing 20% RoE. Almost every European bank got to 20%. But banking wasn’t that good a business. There was one ingredient that did that: leverage. Utilities started giving terrific earnings growth but they are not earnings growth businesses. What did that? Leverage. Infrastructure, airports, toll roads: all started to show great earnings growth from leverage. So they got rerated. Banks looked clever, but when money was cheap, they ended up doing silly things.” Given the practical problems of shorting banks, Bennett’s short book will focus mainly on utilities and real estate where he expects opportunities to emerge through the impact of a double dip recession on theUS and UK housing sectors.
On the long side, favoured sectors, in addition to tech, include health care (but not pharma which Bennett considers a value trap) and consumer staples. Microsoft is one of a very few US stocks likely to be in the hedge fund portfolio and in the concentrated long-only fund Gartmore European Focus, where it is a top 10 holding at 4% of NAV. Another big holding is Elekta, a Swedish medical solutions provider that makes gamma knives to radiate tumours. Bennett’s take on it and other tech longs – German software provider SAP, Software AG, Dassault System – is that the earnings growth they can generate will command an increasing premium during a period of moribund economic activity.
Discussing Elekta, he says: “I think that is a company that can compound its EBIT at 20% annually over the next three years. I am not a great fan of P/Es because the E can be anything. But if you use EBIT we think we are paying about 11 times fiscal 2011. That’s 11 times for a 20 compound. We like that.” On consumer staples, the manager anticipates a re-rating, perhaps redolent of the ‘Nifty 50’ craze of the 1970s when institutional investors flocked to stocks with consistent earnings growth, driving up their P/Es and prices.
“The US is now struggling to avoid double dip and Europe is struggling to avoid deflation,” Bennett says. “In that environment genuine growth businesses – even 5% top line growth could be three times or five times GDP – could do very well. Something like Unilever, which some people argue is expensive at 16X, might surprise. We could be entering a Nifty 50 era for a while. And all of a sudden you might find boring old Unilever at 20 times. I see increasing signs we are heading that way.” Other long plays include Nestle, Danone, Diageo and Pernod, not least because of their exposure to anticipated emerging market consumption growth.
The hedge fund will build up over the coming months to around 50 stock positions long and short with a 3% NAV limit on individual shorts. Four short sector ETFs were established on day one and a short-ETF may have a higher NAV exposure than the limit on an individual stock. ETF exposure isn’t expected to exceed 25% of the portfolio. “ETFs are likely to become a meaningful part of the balance sheet of the fund, but in number they will be relatively small, Bennett says.” “I probably won’t do a tech or pharmaceutical long ETF – I’d rather express that through stock picking – but on utilities, construction and real estate my individual stock shorts are going to be joined by some sector ETFs.”
To be in the portfolio, stocks will require a market capitalisation of over €1 billion, though the fund will occasionally go below that (with a market cap floor of €500 million), but only on long plays. Bennett believes the €1-3 billon range is badly researched given the cut backs in investment banks and brokers. His large cap selections will be to express sector themes whereas mid-caps will be scrutinised with a view to generating performance from under researched stocks.
An important theme is for the fund to be investing in change and doing so early to maximise upside. “It really refers to certain lumbering large caps in Europe,” Bennett says. “Siemens had to have major shocks before it started to change. Philips, too, changed its spots, got out of things and focused on healthcare and lighting and that drove margins up. If there is a management or culture change at certain past value destroyers in Europe – and there have been many of them – through investing in change we aim to get involved early and deploy more capital as the news flow improves.”
Given the downturn in equities markets during May and June (and generally poor returns for hedge fund investors) the timing of the hedge fund launch is tricky. Bennett is taking a safety first approach to deploying capital and expects the opening allocations to extend over several months. He is also mindful of the risk that high levels of volatility create, especially for a new fund bedding in and is clear about what he sees as the chief risk to the fund’s strategy.
Risk of quantitative easing
“The biggest risk to all of our strategies is a major volte face change in European monetary policy, namely, genuine quantitative easing, printing of money, a la America, by Europe,” Bennett says. “It’s being stopped right now by the Germans because they remember the Weimar Republic and hyper-inflation, and they don’t want that. At the moment we are getting a Germanic prescription to what used to be inflationaholics – Greece, Italy and Spain. If tomorrow we get QE from Europe – an all guns blazing QE like in America – then my alpha is going to reverse very quickly indeed. It is a big reason I’m not going to be short banks. That is the single biggest risk to my strategy.”
On balance, Bennett thinks this will happen eventually. He believes the banking system is too indebted and will go bust if tight money prevails. What’s more, at the time of writing in mid-July, there are indications that US financial institutions are paring lending to European banks, so pressure from overseas and within the EU on the German government is building. But he doesn’t expect a change in policy to occur soon. “I think the Europeans will need to have their backs to the wall on deflation before they do it,” Bennett says. “It will be like an oil tanker turning, so hopefully you are going to see it sometime before it happens.”
Fallacy of linear returns
Instead of using quant risk models, Bennett deploys a simple construct to manage risk. “I’ve always had one big principle: my loss tolerance at the overall NAV level. What is the drawdown level that I’m prepared to tolerate before I start crimping the gross and/or employing futures to take the net down. The ultimate master for me, even when I was doing it in my 10th year, was how much of a drawdown was I prepared to take before it really corrupts my long-term compound. But that is a very different stage from where we are starting now. The first prerequisite is not to be at a NAV of 90 by month three. You have to be very gentle in capital deployment for the first two or three months. We will have volatility. But I don’t want too much volatility in the first six months as we get established.”
But Bennett insists that this has nothing to do with the market draw downs in May and June. He claims that the biggest frustration of running a long/short fund is investors saying they want up-side risk, but no down-side risk’. “It is an 11 year view on people believing that there are linear returns,” he says. “There is no such thing. If you do not want volatility do not be in equities. I want investors who can tolerate a bit of volatility. My own personal money is going into this fund. I can personally take the draw downs and the volatility. What I don’t want are geared fund investors who can’t take a 1% draw down. I’m adamant about this. It is nothing to do with the recent downturn, but the last 11 years.”
Building out Gartmore’s pan-European long only franchise has seen AUM rise to an expected €160m in the coming weeks from €20 million in January. Bennett says his main motivation isn’t about raising money but getting the pan-Europe performance into the top decile. Bennett will be helped in this by former GAM analysts Asim Rahman and Christian Billinger as well as Eleanor Cameron, who takes care of operations and liaises with dealing and marketing. The fifth member of the team is Moni Sternbach, the team’s small and mid-cap specialist, who was already at Gartmore. “On long/short I’d like to improve on what we did at GAM and improve Gartmore’s pan-European long only as well as protect the long only business I inherited from Roger. I want to defend and nurture the excellent franchise that he built over the last 16 years,” Bennett says. “Gartmore is also a real equities house. There are a lot of other equity teams. Roger’s desk and my desk work very closely and the teams really share ideas. People don’t see the inner workings of the investment teams. That has been one of the biggest positives I have found after six months. To be surrounded by that and have it at your disposal I find quite exciting.”