Bedlam breaks out with transparency

Bedlam Asset Management’s performance has faltered recently, admits Charles Scott Plummer, sales director, but the firm has won plaudits for its transparent process. James Teasdale reports.

Bedlam Asset Management’s total funds under management have risen strongly from 125m to 205m since the group was last profiled in Fund Strategy (November 21, 2005, pages 30-31). However, recent months have proved challenging for Bedlam, with performance dragging across its fund range.

Charles Scott Plummer, sales director at Bedlam, says: “It has been the worst six months of performance so far. We are conviction-based and our investment process is structured so we can take big bets against benchmarks. We have suffered from our views on Japan and gold and our use of put options in the Global, Japan and Europe funds. But we are still comfortable with the investment process.”

Of the five Dublin-domiciled Oeics registered for sale in Britain with a one-year track record, two are in the top quartile of their respective S&P global investment fund sectors, according to Standard & Poor’s. However, the bulk of the group’s assets are concentrated in its Global, Japan and UK funds, all of which have recorded worse-than-median performance over the period.

Given the absolute return philosophy that forms the basis of the investment process, all funds can hold put options to mitigate risk. Hence, if a manager is concerned that markets may fall, put options can be bought providing insurance against such events. Market risk can effectively be stripped out to leave stock selection to generate alpha.

Following the global equity market correction starting in May 2006, some of the Bedlam funds strongly underperformed as they were not positioned to take advantage of the ensuing recovery. As a result, the process of using put options was revised so that performance could not be impacted to such an extent in future.

Julian Pendock, senior investment analyst and manager of the Europe and Emerging Markets funds, says: “We have overhauled the process so that we use put options in a more sparing and less blunt way. We have introduced cost controls strictly limiting the percentage each fund can spend on puts and have implemented a stop-loss system so that performance cannot be materially impacted.”

The Japan fund has performed poorly, dropping by 26% from January 1 to October 31. Pendock says: “The yen has weakened and this has negatively impacted performance. The fund is also highly exposed to stocks and sectors that will benefit from domestic growth and consumption themes, and this has not helped.”

Holdings in gold mining stocks have hit the performance of the Global fund. “We are sticking to our process using a fairly conservative gold price in our models,” Pendock says. “We do not think the case for gold has gone away. The management quality of some mining companies is variable and sometimes not convincing. But there are still some excellent value stocks out there, like [US-listed] Newmont Mining.”

The 82.5m Global fund is Bedlam’s flagship portfolio, accounting for more than one third of the group’s assets. While in absolute terms it is the worst-performing of Bedlam’s funds over three years, it has posted top-quartile performance (up 54.3%). In contrast, although the strongest three-year returns have been posted by the Emerging Markets fund (up 61.3%), it is the worst-performing fund in its sector.

The Global fund is underweight American equities. Pendock says: “We have long been bearish on the US consumer and have made sure we are not too exposed to the consumer cycle. If you accept that the US housing market was the locomotive for consumption on the way up, it is difficult to see how the two can be decoupled on the way down.”

The portfolio has always maintained a significant weighting in Japan. “Our macro call on Japan has negatively impacted the recent performance of the fund,” Pendock says.

All five funds shown in the table have the same two performance objectives. The first is to preserve capital and the second is to achieve an absolute return of one-and-a-half to three times the yield on 10-year gilts, equating to an annual return of approximately 7.5% to 15%. Each portfolio holds between 25 and 50 stocks and can employ index put options to preserve capital. While funds aim to be fully invested in equities, up to 60% can be held in near-cash instruments.

Capacity constraints are imposed so that investment objectives are not hampered by fund size. The Global fund has a 350m limit, the UK, Europe and Japan funds are capped at 300m, while the Emerging Markets fund has a 175m maximum.

Bedlam applies what it describes as a “self-funding takeover test” when considering potential investments. This process is akin to that used by private equity firms looking for potential takeover targets. Stable operating and net profit margins, an ability to generate free cashflow and attractive valuations are the three principle criteria required.

Quantitative screens filter down the number of potential investments and a macro overlay is applied based on where a country or sector is in its credit cycle and an analysis of a company’s capacity utilisation within the sector in which it operates. Once the investment committee has selected a stock, entry and exit prices are set, with the requirement of at least a 20% expected gain over a 12-month period for a purchase to be made.

Bedlam also prides itself on transparency, with every fund holding shown on its website, together with details of all trades made. These include buy and sell prices and the rationale behind investment decisions.

Dan Kemp, head of fund research at Williams de Bro骠says: “Bedlam is one of the most transparent fund groups in terms of what, why and when it holds stocks, at a time when most houses want to reduce transparency.”

While Bedlam’s investment philosophy is rigorous, transparent and well-defined, its name and marketing approach could be described as quirky.

The group takes its name from the London Bedlam hospital, built in 1247. An excerpt from Bedlam Asset Management’s annual report and accounts for 2005 provides an insight into the rationale behind choosing the name.

It says: “The irony of a fund management group naming itself after a lunatic asylum appealed, given the range of unsuitable and dishonest investment products which are created every year for trusting investors Following our accidental discovery of a report in the British Journal of Science from 1876 on the Bethlehem Royal Hospital, we had no choice, for it reads: ‘The management is so good that each year one half of all inmates are returned as cured.’ This is a tremendous success rate so, irony apart, we decided we should create a business to rescue investors from their delusional fund managers.”

Scott Plummer says: “The Bedlam name was an ironic dig at the industry. But it also stops performance junkies from investing with us. Before people put money into our funds they must make a leap of faith past the name and understand and engage in the investment process.”

Bedlam’s marketing campaign at launch highlighted fund management groups charging investors even when performance was weak, including slogans such as: “They’re bleeding you dry – don’t pay for poor invest-ment performance.”

The group launched its first funds in 2002 with a “no gain, no fee” charging structure (the ‘A’ share class). Investors are subject to a maximum quarterly fee of 1.25% of assets, with no front-end load. If the net asset value of shares has increased by less than 1.25% in a given quarter, then no fee applies for that quarter. If the return is above 1.25% then a charge of up to 1.25% of assets is applied, which must not reduce client returns to below the minimum 1.25% threshold. Hence, while investors will not pay for poor performance, they will incur higher annual management charges than those investing in traditional retail funds in strongly or even moderately rising markets.

A new ‘B’ share class was added in November 2004, with the launch of the Bedlam Japan fund. The shares are subject to a 0.9% annual management charge and a performance-related fee of 20% of returns over a specified hurdle rate, again with no initial fee. The 20% load applies to all gains made above three-month bank deposit rates, with the previous quarter net asset value serving as an ever-rising high watermark.

This share class was rolled out to the rest of the fund range at the beginning of 2005. Most new money is invested in B shares, says Scott Plummer. “Institutional investors tend to prefer B shares, but people still invest in the original share class because they know they will never pay a fee unless they make money,” he adds.

Kemp says: “We have investments in most of the Bedlam funds, although we have not bought too much recently. While it is quite a quirky group, Bedlam is one of the most novel and innovative fund houses in the City, run by capable fund managers.

“It was one of the first fund providers to charge performance fees rather than a flat annual management charge, which is becoming increasingly mainstream. To start a business on that premise was risky and I applaud it for that.”

The most recent addition to the group’s Oeic range came in May 2006 with the launch of the Bedlam 200 fund. Based on the same investment process, the portfolio is structured differently from the rest of the range, both in terms of its investment objective and charging structure.

Scott Plummer says: “The fund still has an absolute return objective but has a target dividend yield of 3.5%. For every 100,000 invested we pay out 875 for each of the first three quarters and pay the excess from the dividend account at the end of the fourth quarter.”

The stock ideas are taken from the UK and Global funds and companies need to have a three-year history of strong dividends and an expectation of rising yields. The portfolio is at least 50% invested in British equities.

The fund size is not capped. Instead, once it has amassed 200 investors a 3% front-end load is applied. More than 120 investors have so far invested into the 27m fund, which has a 1% AMC and a 100,000 minimum investment amount.

Bedlam is also considering a closed-ended vehicle. “We are undergoing initial due diligence in relation to the launch of an investment trust,” says Scott Plummer. “It would use the same investment process and objectives as the Global fund, but tap into a different client base.”

The intention is for the fund to be a focused portfolio with a maximum number of 25 holdings and no gearing used. It would be called the Cherry Picker trust, says Scott Plummer.

With two new hires in 2006, the investment team comprises seven members. Natan Levy joined from Rensburg Investment Management, while Duncan Weldon joined from the policy advisory unit of the Bank of England. Both are investment analysts. The named managers on Bedlam’s funds are Jonathan Compton, managing director, Ian McCallum, chief investment officer, Matt Jones and Pendock.

Looking forward, Scott Plummer says: “We need to get performance into gear. It looks like the Japanese market has bottomed out and we will continue to stick to the investment process. We are convinced by it and our clients will get more of the same.”

Kemp says: “Most investors and institutions expect fund management to be dull because they want safe, dull people looking after their money. Bedlam is in no way dull; it is a breath of fresh air.”

BEDLAM ASSET MANAGEMENT

was established in 2001 by its managing director, Jonathan Compton. Six sub-funds are offered to investors within the group’s Dublin-domiciled Oeic. Bedlam runs both retail and institutional mandates, with a total of 205m in assets under management. The group comprises seven investment professionals using an investment process based on capital preservation and targeting absolute returns.


Bedlam Emerging Markets