- You have two successful Japanese hedge funds. What
made you decide to launch a long only fund?
Arcus has always managed long only funds alongside its
hedge funds and, like the hedge funds, these have been
very successful. All of the funds have outperformed Topix
substantially. However, until now the long funds have
been available only to Japanese investors; the Arcus Japan
Value Fund ("AJVF") will be the first Arcus
long fund open to international investors.
We reckon that outstanding value is available in Japanese
small/micro caps and stocks with limited liquidity. By
way of illustration, one of our more conservative long
funds recently had the following profile: an average PER
of 9x, an average PBR of 1x, and average growth of 8%.
That's an attractive value-to-growth ratio by any standard.
We hold lots of positions like this in our hedge funds,
but in many cases we can't expand them because they are
constrained by risk control and liquidity. Now that the
hedge funds are closed we see AJVF as the ideal vehicle
to make these exposures available in concentrated form.
- Can you explain your investment process for this fund?
The fund will seek out a range of different kinds of
undervalued stocks - classic deep discount value stocks,
net nets and extremely low P/Es and some quasi-distressed
companies, but we will also hold GARP stocks, undervalued
new economy stocks and some undervalued major companies
if they look compelling enough. Our industry knowledge,
quantitative tools and screening are used to highlight
candidates that are then selected on the basis of fundamental
analysis.
This is the process that we have used for the last decade
and in all our funds.
-
With a strong emphasis on fundamental research and
3500 companies to cover in Japan, why do you prefer to
be based in London rather than Tokyo?
London is a great base for regulatory reasons and for
convenience, but it's a little misleading to see us as
based solely over here. Peter, our strategist, is based
full time in Tokyo and Mark, the fund manager, spent three
months there last year. Most of his time was spent visiting
companies and we visit well over one hundred companies
a year in Japan, as well as the several hundred we meet
in London.
It is certainly important to be firmly grounded in Tokyo.
It tends to be the big, well-known, foreigner-friendly
- in other words, "expensive" - companies that
visit London. On balance our longs come from visits in
Japan and our shorts from London. However, there is also
a big advantage to distance - it gives you perspective.
Our style is highly contrarian and it's important to us
to avoid being caught up in the latest fad or fear.
- Is your strategy flexible? Would you consider large
cap stocks if you uncover some sudden turnaround in 'living
dead' companies?
Until recently investors hated zombies so much that
few of them are large caps any more! Peter and Robert
wrote an article on this for Swisshedge a few months back,
laying out our perspective on the impact of the bear market
on equity valuations. There is a price at which zombies
are a buy, and there is enormous upside for the ones that
survive. Resona is a classic example.
Of course, since the Resona rescue such stocks have performed
strongly and it is no longer obvious that one is being
paid for the risk, but the time may well return…
That is why we have made the mandate flexible. Right now
we don't know what will be cheapest in a year or two,
but that is where AJVF will be.
- Your capacity is quite low at $100m. Is this purely
determined by liquidity and if so how would you go about
increasing capacity with increased investor demand?
Capacity is constrained by the AJVF's objective of
maximising performance. Many of the best investment opportunities
are in stocks with rather low liquidity. AJVF has been
structured to allow it to invest in such stocks, with
a tight gate for redemptions, but there is always a limit
to the size of investment that can be made without hitting
price. Our objective is to provide a significant exposure
to the best investment opportunities in Japan and, as
with our hedge funds, we are not going to let size get
in the way of this.
It is possible that the fund will close below $100m,
depending on market conditions, but I don't think any
increase in this limit is at all likely. If we are right
about the attractiveness of these assets they will be
marked up significantly - in some cases by a factor of
two or three - over the next few years. Of course they
will then become more liquid, but I do not think it would
make much sense to increase the fund size after the best
returns had been made.
-
What are the advantages of running a long only strategy
as compared to a long/short strategy?
AJVF grew out of a kind of frustration with long/short.
We have set up the hedge funds with tight risk and liquidity
parameters. These are constraints that restrict our ability
to increase some of the very best positions. There are
great stocks out there that we would love to leverage
into, but can't because it would blow Zensen's volatility
budget of 12-15% a year, or just be unmanageable if we
face a substantial redemption some month.
That is where AJVF comes in. It is going to be a high-volatility
fund. We want investors who want to take risk and who
have a long-term vision on this asset class. That is why
we have tight redemption terms. We can take more exposure
because investors are less focussed on the short term.
- What is your fee structure?
We charge 2% fixed and 20% performance - a hedge fund
structure. Investors will have the choice of an absolute
performance fee or one relative to Topix.
- Generally long-only absolute return funds tend to
charge lower fees than hedge funds. How do you justify your
fees?
Arcus has a strong track record of managing long only
funds.
| |
Typical
Fund
Size |
Years |
Absolute
Fund
Return |
Topix
Return |
Relative
Perf |
Annual
Relative
Perf |
| PSJEF |
$25m |
4.50 |
57% |
-18% |
+91% |
+15% |
| AVF |
$45m |
4.75 |
62% |
-8% |
+76% |
+13% |
| Leaders |
$70m |
3.00 |
9% |
-31% |
+58% |
+17% |
| Neo |
$5m |
3.50 |
21% |
-44% |
+116% |
+24% |
| Returns are for funds and managed accounts for which
Arcus is investment advisor and are quoted net of all
fees, from inception to September 2003 or to fund closure.
Past performance is not necessarily indicative of future
returns
|
PSJEF is probably the most comparable to AJVF in terms
of mandate, but our relative returns on all these long
funds are comparable to the absolute returns normally
seen on hedge funds so we don't see any reason to be shy
on fees.
We are not a commodity manager. We can't take $1 billion
and continue to deliver this kind of performance, so we
prefer to keep the funds small and make money when we
do a good job for our clients.
-
What would be the difference in investor appetite
for this fund as opposed to your long/short strategy?
We see AJVF and Zensen as fulfilling quite different roles
in clients' portfolios. AJVF will appeal to investors who
want unhedged long exposure to what we think is the most
exciting part of Japan Inc, and who want it for the long
term. Zensen is a cash-relative product taking significantly
less risk.
-
Due to the success of your long/short strategy do
you expect to raise assets from investors who have allocated
to the Arcus Zensen Fund and the Arcus Japan Long / Short
Fund?
We have strong indications of interest from investors in
our hedge funds, and also significant commitments from new
investors. Though it is still early days - Launch is 1
December - we think the fund will open with well over $30
million.
In fact the strong appetite for this kind of exposure
is one of the reasons we like this class of stocks. They
haven't really moved yet, but with the levels of interest
we are seeing it is possible that they will move rather
soon. We want to be invested when they do.
-
Do you feel that Japan markets have finally recovered?
Topix is currently up +36% from its March low, which leaves
it down -40% below its peak in early 2000. Is it half way,
or just the beginning? In every past cycle, the problem
for Japan is that the market recovery has allowed the authorities
to back-pedal the ongoing reform. It could be the same story
again.
On the other hand - as Peter noted in a strategy comment
to our investors earlier this year - this time it is different.
This time, the usual flurry of spring market support was
muted. The bounce dates not from administrative manoeuvres,
but from Resona's bankruptcy, and there is a good case
that this is healthier. At least the market now sees a
way out; the banks may have capital adequacy problems
but the government is now following a pragmatic damage-minimising
strategy, and monetary policy is very supportive. This
gives reasonable prospects of exiting deflation.
At the moment earnings momentum is strong, industrial
production is strong, world markets are strong, export
demand is strong and policy is supportive. We can't say
how long this will persist, but while it does there is
certainly room for a further rise in the market.
-
What are your targeted returns and how do you plan
to minimise your volatility? What risk procedures are
in place to do this?
We are always a little uncomfortable talking about target
returns, because whatever we say we know the reality will
be different. On average we have had double-digit outperformance
on our long funds, so I guess that gives an indication of
scale.
Maybe it is better to talk about risk. We actually use
the same process for all our funds. We have developed
a proprietary system that gives robust forecasts of the
marginal contribution that each stock in the universe
- both our positions and all possible candidates - makes
to fund risk. In other words, it forecasts how many cents
we add to our risk budget if we put one more dollar into
the stock. This lets us set the fund's risk exposure where
we want it.
In Zensen, we use this to set a budget of 12-15%. The
risk system is actively telling us to limit positions
to stay within this range. In AJVF we use the same system
so that we can see where our risk is, but it does not
really constrain positions in the same way. Both volatility
and tracking to Topix are going to be on the general scale
of 20%.
Perhaps it is repeating an earlier point, but this fund
is only for people who really want this exposure. Zensen
aims to control risk, AJVF aims to take it.
-
Looking forward, how do you envisage absolute return
investment strategies or styles evolving over time?
We can't really say much about the way in which the industry
will evolve, but we don't expect to make major changes within
Arcus. The real driver is always bottom-up stock analysis,
which is Mark's key contribution: is it cheap, and why?
Peter's macro view provides context. In a year or so we
may want to sell this stock; what will the market be talking
about then? Should we be looking for companies that will
be the stars of the coming recovery, or those that will
survive the coming crunch? Robert's tools provide the glue
that lets us handle large portfolios and answer the perennial
favourite, why did we lose money?
It is a recipe that seems to work. AJVF is just about applying
our established approach to the stocks we love best.
