Fund name: Bridgeway Balanced (BRBPX)

Objective: “To provide a high current return with short-term risk lower than or equal to 40% of the stock market.”

Adviser: Bridgeway Capital Management.  The first Bridgeway fund – Ultra Small Company – opened in August of 1994.  The firm has 11 funds with about $3 billion under management.  Six funds have received star ratings from Morningstar.  Five of those six – Aggressive 1, Aggressive 2, Ultra Small Company, Ultra Small Company Market, Micro-cap and Balanced - are five-star funds.

Manager: Richard Cancelmo, who is also head of equity trading.  He has been the fund’s manager since inception.

Opening date: June 29 2001.

Minimum investment: $2000 for both regular and tax-sheltered accounts.

Expense ratio: 0.94% after an apparently-permanent fee waiver; 1.19% otherwise.

Comments: They were one of the finest debate teams I encountered in 20 years.  Two young men from Northwestern University.  Quiet, in an activity that was boisterous.  Clean-cut, in an era that was ragged.  They pursued very few argumentative strategies, but those few were solid, and executed perfectly. Very smart, very disciplined, but frequently discounted by their opponents.  Because they were unassuming and their arguments were relatively uncomplicated, folks made the (fatal) assumption that they’d be easy to beat.   Toward the end of one debate, one of the Northwesterners announced with a smile: “Our strategy has worked perfectly.  We have lulled them into mistakes.  In dullness there is strength!”

Bridgeway Balanced is likewise.  This fund has very few strategies but they are solid and executed perfectly.  The portfolio is 25 – 75% mid- to large-cap domestic stocks, the remainder of the portfolio is (mostly Treasury) bonds.  Within the stock portfolio, about half is indexed to the S&P 500 and about half is actively managed using Bridgeway’s computer models.  Within the actively managed part, half of the picks lean toward value and half toward growth.  (Yawn.)  But also – here’s the exciting dull part – particularly within the active portion of the portfolio, Mr. Cancelmo has the ability to substitute covered calls and secured puts for direct ownership of the stocks!  (If you’re tingling now, it’s probably because your legs have fallen asleep.)

These are financial derivatives, called options.  I’ve tried six different ways of writing a layperson’s explanation for options and they were all miserably unclear.  Suffice it to say that the options are a tool to generate modest cash flows for the fund while seriously limiting the downside risk and somewhat limiting the upside potential.  At base, the fund sacrifices some Alpha in order to seriously limit Beta.  The strategy requires excellent execution or you’ll end up losing more on the upside than you gain on the downside.

But Bridgeway seems to be executing perfectly.  Over the past three years, the fund has returned 11.9% per year and it has returned about 6% per year since inception (that compares with a 2.2% return in the S&P500 and a 2.8% return for its benchmark).  As of the 12/31/05 Semi-Annual Report, Lipper ranked this fund 61^st of 396 balanced funds since inception and Morningstar ranked them as 35^th of 365 conservative allocation funds for the preceding three years.  Which they’ve accomplished with little volatility: their standard deviation is 4.4 (the S&P 500 is 7.8) and they were the 2^nd best performer among the funds we’ve covered during the recent (May 2006) downturn.

All of this occurs within the context of Bridgeway’s highly principled corporate structure: small operation, very high ethical standards, unwavering commitment to honest communication with their shareholders (if you need to talk to founder John Montgomery or Mr. Cancelmo, just call and ask – the phone reps are in the same office suite with them and are authorized to ring straight through), no money wasted on marketing, modest salaries (they actually report them – Mr. Cancelmo earned $318,657 in 2004 and the company made a $10,000 contribution to his IRA), a commitment to contribute 50% of their profits to charity, and a rule requiring folks to keep their investable wealth in the Bridgeway funds.

But very few people have chosen to invest in the fund – net assets are around $75 million.

Why?  Because this fund is dull. Dull, dull, dull.  Dull stocks and dull bonds with one dull (or, at least, moderately dense) strategy to set them apart. 

Bottom line: “In dullness, there is strength!”  For folks who want some equity exposure but can’t afford the risk of massive losses, or for any investor looking to dampen the volatility of an aggressive portfolio, Bridgeway Balanced – like Bridgeway, in general – deserves serious consideration.

Company website: http://www.bridgewayfunds.com/fundBF.asp

Roy's gratuitous comment: I get the impression that David likes Bridgeway.

June 1, 2006