Should You Buy a Fund That Pays You to Invest?

Not so long ago, Bridgeway Aggressive Investors 1 (symbol BRAGX) was a top-performing fund. From its inception in August 1994 through 2007, the fund returned an annualized 20.8% -- almost double the return of Standard & Poor’s 500-stock index.

Then came disaster. Few funds did well in 2008, but Bridgeway’s performance was especially horrific. It lost 56.2%, declining 19 percentage points more than the S&P 500.

A lot of good stock funds collapsed during that cataclysmic year. But most recovered impressively in 2009 and 2010 as stocks rebounded from the bear market. Not Bridgeway, however. Aggressive Investors 1 has only stayed even with the S&P 500 since the end of 2008.

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Is there any good news here? You could say that the reopening of Aggressive Investors 1 to new investors qualifies. But you could also ask why you should bother getting excited about a fund with such a lousy record.

And, indeed, recent results have gravely undermined Aggressive Investor 1’s long-term numbers. Over the past five years through January 28, the fund ranks in the bottom 1% of funds that focus on fast-growing, midsize companies. Over the past ten years, the fund ranks in the 58th percentile against its peers. Only when you consider the fund’s record over 15 years -- an annualized return of 12.8% -- does it shine, ranking in the top 1% of its peer group.

But here’s where things get interesting: The fund’s record is now so bad that it is paying customers to invest. This isn’t a joke. The expense structure of Aggressive Investors 1, as well as other Bridgeway funds, calls for higher management fees when the fund beats its benchmark and lower fees when it trails. Based on the formula, Bridgeway’s sponsor is now paying into Aggressive Investors 1 at an annual rate of 0.51% of assets.

Why own Bridgeway?

By itself, the fee deal is not enough reason to invest in Aggressive Investors 1. But John Montgomery, Bridgeway’s founder and lead manager, offers several arguments for his embattled fund.

First, he says, Aggressive Investors 1 has almost always done particularly well after periods of lousy performance. Not that he’s unmindful of the damage 2008 did to investors’ wallets. “We badly underperformed the market, and that added to the pain,” he says. “I get an F for 2008. It is a big black eye for me because we’re specifically trying to avoid underperforming in a down market.”

Montgomery is a “quant” -- that is, he and his seven analysts and co-managers program computers to pick stocks. They continually fine-tune their models to improve performance.

In 2008, Montgomery says, most quantitative methods failed. He says he learned that in a market driven by dramatic economic events, “all bets are off.” Few investors gave much thought to price-earnings ratios or other fundamental data. Instead, the market keyed off fears that the economy might fall into a depression.

During the rebound, which began March 10, 2009, many of the stocks that had been socked the hardest bounced the highest. Stocks of highly indebted companies did better than those with solid balance sheets, Montgomery says. Stocks of teetering financial companies did better than those in many other industries, he says. Consequently, Bridgeway failed to recoup its losses relative to the market.

Over time, Montgomery argues, the fundamentals -- profits, financial strength, dividends and such measures of value as price-earnings ratios -- are the main drivers of performance. In other words, good companies will do well, at least when they’re bought at inexpensive prices, and bad companies will flounder. Bridgeway’s computer models are designed to uncover the good stocks and steer the managers away from the bad ones.

It’s hard to argue with those assertions. But there have always been questions about Bridgeway -- questions I wish I had raised before recommending Aggressive Investors 1 numerous times in past years. Montgomery plays it close to the vest. He gives few details about how his funds’ quantitative models work. Aggressive Investors 1 is also extremely volatile -- 35% more volatile than the S&P 500.

Usually such volatility is a good predictor of bear-market performance. But for years Aggressive Investors 1 managed to hold up reasonably well in down markets. When things finally reverted to form, the fall from grace was breathtaking.

On the plus side, Montgomery strikes me as a disciplined and passionate investor. None of his analysts or co-managers left during the years in the wilderness. In fact, Montgomery has added two senior people over the past couple of years.

I’m less confident than I used to be about Bridgeway, but my hunch is that Aggressive Investors 1 will do well in coming years. After well-run funds with superb long-term records disappoint for a couple of years, they typically rebound. Methods that were out of favor for a while come back into favor. I’d wager that will be the case here. But the fund's volatility scares me. Do you want to take the chance of owning such an aggressive fund in your portfolio? If you do, don't overdo it.

Steve Goldberg (bio) is an investment adviser in the Washington, D.C., area.