It is a lot harder for some allocators of hedge fund capital to assess John Bennett’s approach to running money at GAM. For one the manager describes his style as pragmatic. The deep-thinking Glaswegian has a very strong suit in a capability that computers can’t get near, even if they use neural nets or genetic algorithms: John Bennett has good intuition. That is not to say that the whole of his investment process for running $1.3 billion dollars of equity hedge capital (and the same again in long only retail and institutional funds) is carried on the back of an envelope, or resides solely in his head. It doesn’t. There is a dedicated back office and middle office person provided by GAM and he utilises the effortsof two investment managers and an investment analyst within his team. But Bennett is capable of making imaginative leaps in assessing information, can take data and understand its significance without creating an econometric model to derive it. Information can seep into such a manager’s mind and sit there until the spark of a catalyst or latest piece of information confirms or denies an impression.
A manager like Bennett is capable of working with incomplete information. This is a key skill in personalised money management, as opposed to process-driven money management. It is in the nature of traded markets that there is uncertainty. Stock markets simultaneously discount the range of possible scenarios (futures) to give a probabilistic best estimate of the collective wisdom of all market participants – the current stock price. Money managers take positions on the basis that their assessment of the probabilities for some of the industry/macro factor/ company specific developments is substantially different from the collective. To get to the point of knowing something different from the markets takes research.
“I don’t travel to see many company managements myself,” says the 42-year old Bennett, “that is mostly done by my colleagues.” The direction for research efforts for the funds for which John Bennett is responsible (the €833m GAM European Equity Hedge Fund, the €198m GAM European Small Cap Hedge and the long-only funds) is set at the team’s regular Research Meeting. This meeting covers events and new information that has arisen or is expected for companies in the portfolios or on the active watch list. Bennett sets the overall tone and direction of the funds and allocates research accordingly. Each of the members of the GAM European equity team is a generalist. They each crunch numbers on companies. They don’t specialise by sector or country. “That we don’t specialise is deliberate,” says the team leader. “I learned a lesson from my time at Ivory & Sime, where I recall investment professionals that specialised in particular sectors would be on the defensive about their sector because that was all they had. That is no basis to be logically allocating capital or someone’s time. I would prefer to send a person to a company meeting that was unfamiliar with the management. You get a new perspective on the company then, and maybe with less of a behavioural bias in attitude to the stock.”
It is not that John Bennett does not meet company managements at all – he had seven company managements into his offices for one-on-one meetings last week – but he finds it difficult to find the time to travel to see them. When he meets the managements himself it can shorten the time to make the related investment decisions. “We have had a holding in our small cap hedge fund of Norwegian medical software company Profdoc ASA since September last year. I met the Chief Executive recently and doubled the size of our holding afterwards,” discloses the GAM Investment Director for European markets. “Meeting the smaller company managements helps with our industry knowledge, and can help with the bigger picture too. For example, it is well known that I have been constructive on the outlook for various parts of the German economy for a couple of years. We had a meeting with a Swiss auto parts supplier a few weeks ago – they make cast-iron parts – they told us that their American business and Asian business was still good, but they also mentioned that business was picking up in Germany.” Such insights into current trading are added to anecdotal evidence from other businesses, and the GAM take that the new German government is doing something about employment in the country, and so John Bennett has been a lot more constructive on the outlook for German retailers than the market generally. The funds have benefited from exposures to Praktiker and Karstadt Quelle in the last year.
“I think the consumer and service sectors in Germany will do better than most expect, particularly in Bavaria. What I often use as a prompt to action is not necessarily good news emerging. I like to see the bad news lessening, and when business conditions flatten out that is often the first phase of making money off a theme – just the absence of bad news can be enough.” This was very much the background for the German banks two years ago. “I owned them then as the managements ran their businesses better – it was about reducing bad debts and improving margins as the industry consolidated. Now I own German banks for a different reason. I see the emergence of private equity buyers and the likes of Cerberus operating in Germany supporting property prices. These transactions are supporting the values of the assets against which bank loans have been made. If you like, the first phase was all about the denominator in the ratios of returns on assets [Bennett’s favoured metric is cash flow return on investments (CFROI)]. Now I can see loan growth, and so the numerator can drive the story in German banks and the consumer economy.”
Commerzbank remains one of the largest holdings across the funds run by John Bennett. It has been a significant holding for over two years. Over that time his funds have benefited from holdings in other German banks (and banks in Italy) as the consolidation theme played out. This illustrates that not all hedge funds are run with high turnover on sheer momentum of stock prices. The holdings were taken on a change in momentum of the business of banking – the stocks reflected the change over a period of years, and the holdings remain, though the rationale by now has become a combination of growth and value. And the holding period of the banks is not unusual within the funds. The emphasis on CFROI has helped identify many takeover targets in the last year or so as M&A picked up in Europe. The small cap hedge fund, run by Bennett with the assistance of Patric Slama, had 17 takeover bids for companies held in 2005, though the fund does hold over 200 positions (197 long and 12 short at the end of February).
Table 1 Returns of Small Cap Hedge
|GAM European Small Cap Hedge (EUR)||8.21||17.11||19.33||12.73|
|MSCI Europe Index in €s||18.49||12.65||26.68||5.50|
*9months #to end March
The GAM Small Cap Hedge Fund was launched in April 2003 and has matured in style. As positions were added the fund didn’t have a gross over 100% invested until early in 2004. Through 2004 more longs were found to take the number of longs up to 200 or so by the end of that year (111.8% in long book). Whilst there have always been stock shorts, to the end of the 3Q last year they never amounted to much beyond low single-digits of exposure, Bennett preferring to manage the net with short futures or short ETFs. It is critical to understand that Bennett only shorts stocks for profit, not to hedge. In Bennett’s mind that we have been in an equity bull market since the launch of the small cap hedge fund has meant that it was always going to be difficult to generate profits from the short book. For the last six months the short equity book has been slightly larger (in the teens as a percentage of NAV), as more opportunities to profit from shorts emerged.
The management process of the GAM European equity team is clearly adding a lot of value through stock selection to the small cap hedge fund. What Table 1 doesn’t show is that the net exposure in 2004 was 50-80% for much of the year as Bennett managed the net with futures. So, the fund handsomely outperformed the broader market indices with less beta than many European hedge funds at the time. In 2005 the net has typically been 90-100%, as index shorts were used to a lesser extent in the year.
A natural development
There are a number of small and mid-cap hedge funds devoted to European markets. The surprising thing to many was the launch of such a product at GAM, not typically thought of as the home of niche products that are not very scalable. But it turns out to be a very natural development for John Bennett himself, demonstrating clearly that the hedge fund business can be about the peculiar talents of the manager. When Bennett joined GAM almost 14 years ago the firm was run by it’s founder Gilbert de Botton. “He was one of only two people in my time here that could really spot investment talent and bring them in-house,” says the firm’s European equity honcho. “I don’t know if he knew then, but I had never bought a blue chip stock in my life up to that point. I had been a small cap specialist at Ivory & Sime.”
The development of the GAM small cap fund has been shorter and smoother than that for the billion dollar GAM European Equity Hedge Fund. As has been recorded here before, 1998- 1999 was a great time to start an equity hedge fund in Europe. The market environment had more volatility than we have seen in recent years, and in 1999 there was a wall of liquidity flooding into markets thanks to central bank policy. Then in 2000 was the peaking of the bubble of technology stocks. These were big clear trends to dictate the shape of hedge fund balance sheets. John Bennett confesses that he did not play the markets as well as he could have in 1998 – it was the first time in his career that he let a big picture view dominate. At this time he had a fear about America’s twin deficit problem impinging on financial markets, as well as the LTCM and Russia crises. He did read the markets well at the end of 1999 and explicitly recognised the peak of the technology sector bubble. So he made big returns being net long late in 1999 and early in 2000. He shorted technology stocks in tranches in February, March and April of 2000. The hedge fund became betaadjusted net short to the extent of 15% shortly thereafter. The volatility exhibited by stocks was large in the years after the start of the new millenium, and many hedge fund managers, Bennett amongst them, did not feel the need to run with large balance sheets to make money. The GAM hedge fund ran with shrunken gross and net from 2001 onwards as a defensive mode was adopted for bear market conditions.
Table 2. Returns of GAM European Equity Hedge USD and European Equity HF Index 1.42
Source: HedgeFund.net *Barclay European Equities Index.
Note: Returns until the end of January 1999 are for the USD class, the Euro Fund was launched 27/01/99
This strategic positioning worked well for John Bennett in 2001 and 2002, and the returns of GAM European Equity Hedge stood up well against the peer group (see Table 2). Global equity markets bottomed in March of 2003. Equities did not bottom exhibiting tremendous value, but they did bottom. “For the second time in my career I took too much account of the macro environment,” says the GAM portfolio manager. “There were a lot of smart strategists pushing the idea of America’s economic problems precipitating recession and really hitting the value of the dollar. And I fell for it. That idea had far too much weight in my thinking on markets at the time.”
Bennett had not lost money for investors in his hedge fund vehicle, he just hadn’t made much money for them, and by 2003 there were enough managers in the European equity long short area that the alternatives were commanding attention for some of the investors in Bennett’s fund. “A few of the investors that came into the fund in 2002 were pulling that capital out in the second half of 2003,” states the manager. John Bennett is a reflective character, and he was experiencing his own “Long Dark Tea Time of the Soul” for his investment approach to the then current markets. “The decisive moment came when I was on holiday with my family in Iceland. We were whale-watching out at sea on a boat when a call came on my mobile from a sales trader. Intel was up 8% on an upgrade. I had been short this sort of company for so long, and here it was letting rip to the upside. I was initially depressed over it, and was thinking over the American economic situation. Then after some hours of waiting a humpback whale appeared, and it turned into a great day with my family. Later that day I thought “Intel can’t hurt me anymore, the market’s closed now.” I had milked the negative feelings, and just decided to get over my hate affair with the US and with macro. “Even if you’re wrong, get over it. More importantly, get back to what you’re good at,” I told myself.” He has forsworn from the macro ever since.
Table 3. Statistics for GAM European Equity Hedge USD
Highest 12 Month Return 42.08%
Lowest 12 Month Return -16.08%
Longest Losing Streak 4 months
Maximum Drawdown -19.21%
Sharpe Ratio (Annualized) 0.40
Std. Dev. (Rolling 12) 12.54%
R-Squared (to MSCI Pan Euro Index) 0.16
This change of mindset meshed with a growing feeling Bennett had that hedge fund managers had unwittingly adopted the risk controls of their clients. “I had had a lot of meetings with potential investors where the concepts of drawdown and monthly losses had been discussed at length. There was a mantra from across the table of managed downside risk. It didn’t sit comfortably with me.” According to the Scotsman he could feel the whole industry going through the same tension as himself – there was a risk of delivering bond-plus returns to investors, and that was not going to be enough for very much longer. He resolved to get back to double-digit returns through being true to himself as an investor. He saw that it would require a larger net, and that there would be losing months, but that was a necessary cost to produce the desired return for the markets ahead, as he saw it.
Quite appropriately, Bennett decided to take his new message of how he was going to run the GAM European Hedge Fund to his existing clients. They had to hear first-hand of the changes to come. “I remember one investor ejaculated “Hallelujah” out loud at one meeting,” says a smiling Bennett. “What I have done since is focus on my core skill set – picking stocks and themes to make the returns.” The manager has effectively co-opted his clients to accept his own preferred risk tolerance. He manages money with a medium-to-long time-frame, so a losing month here and there indeed does not matter. It turns out that Bennett’s large cap hedge fund has had fewer down months than the index for his strategy since the re-vamp.
The Balance Sheet History given in Table 4 shows that Bennett has enacted his plan well.
Ironing out the wrinkles
John Bennett is not content to carry on doing exactly what he has been. “You need to keep refining the process;” he explains, “ironing out the wrinkles, and removing the errors. I have made mistakes, and I know there are areas I can improve on.” After his admission on macro, Bennett also confesses that he is known for being early on his investment ideas. “I’m not as good a judge of momentum in markets as other people. I really admire that Andrew Green (who runs GAM Global Diversified and GAM UK Diversified) can have 30 basis points in a stock, and maybe take it to 60 basis points, but when it has momentum he has 260 basis points in it.” This has led to the European equity manager taking several initiatives to enhance the chartist input to his process. “I’ve tried adding people to the team to add the technical analysis skills we didn’t have. I’ve failed twice doing it that way – once I had someone who wasn’t experienced enough and another time I got someone in who didn’t work well with the rest of the team.” This ability to interpret the implications of price and volume action is still considered an important omission by Bennett, perhaps recognising that a successful implementation could add a great deal to his funds’ returns. He feels he has to get better.
“The € class of GAM European Hedge has delivered a compound of 11.7% [against 4.7% for the market and 3% for cash] but I need to get better at investment management,” says the well-regarded Investment Director. “For me it is not about the baggage of making wealth for myself. I have that covered by now. This is a game, and I want to get better at it. I have learned from my mistakes: I agonise over things, let them simmer in my brain, and then act. So I tend to get over whatever it was that was bothering me. I will nail it, this game,” says a determined Bennett.
It is perhaps surprising to discover that John Bennett is in the minority of European equity hedge fund managers that uses options to manage their portfolios. His funds have long holding periods, he is not a trader, he truly invests on fundamentals, and interpreting charts is not a strong point. Not usually the circumstances for an appropriate use of the much-maligned derivatives, but the seasoned portfolio manager has found some uses of options that fit very well with his style of managing money. At the stock level Bennett can hold large positions in big companies, and can tailor the size of the position with the value of a stock he knows well. “I might have a 9% position in a stock like British Telecom. If it has a little run, I might recognise that I wouldn’t mind being taken out of 2% of it at 15% or more above here.” Such over-writing with calls has been a less frequent strategy than under-writing with puts over the last year. The GAM manager would not go further out than 12 weeks, and might look to add to a position 10 or 15% down from the prevailing price with short put options. The writing of option premium contributed 115 basis points to gross fund return last year – “I like to see it as paying for part of the management fee,” says Bennett.
The other use of options has more of a structural element to it: Bennett has been buying put protection for the whole portfolio. This has been done using index puts on the DJ EURO STOXX index. He has no doubt that it has been effective in dampening the downside participation of his hedge fund with the market. “Only last week the market had a 70 basis point down day. A fund like ours with a net exposure of around 100% on a beta adjusted basis should be down around the same as the market, but we were actually down 50 basis points. I still use short futures when the need arises and improve the downside characteristics further,” clarifies Bennett.
GAM’s John Bennett makes a very good portfolio manager. His cogitative take on portfolio shape and investment process fit well with a fundamentally-driven, bottom-up stock selection process that yields a long holding period. He controls several billion dollars worth of assets, enjoys widespread recognition, and has been a top-ranked investment manager with all the rewards that that brings, and it is to his credit that he is not content to leave things as they are. His use of options and futures as well as deeper understanding of shorting since the last bear phase gives him the capability of positively surprising potential investors in the next market downturn. He is not structurally long-biased – he just happens to interpret a medium term view of market potential through balance sheet shape, and that view has been positive for several years. He is looking to fill a hole in his process that he has recognised for some time. Should he add an effective interpretation of market flow and stock price momentum to the range of capabilities in his team, then that should improve the timeliness and quality of decision-making. This should improve the return on capital employed, but crucially will allow the style of management to develop. Multiple holding periods could be used; portfolio shape may alter if the degree of conviction changes; there could be more of a core/non-core approach; and the variation in the size of positions should add more value. These refinements are ahead. As it is, he has his powerful intuition to bring to bear, and it would be a mistake to under-estimate the determination of the profound John Bennett to master the game he has chosen.