Arcus Investment was established in the mid 1998 by three
partners who own the company, Peter Tasker, Robert Macrae
and Mark Pearson. Arcus runs two other hedge funds, Arcus
Japan Long/Short Fund and Arcus Zensen Fund.
- For new investors, can you explain Arcus' investment
approach? Specifically, how are the principals' macro, fundamental
and quant expertise incorporated into this approach?
The three principals share a straightforward value philosophy
- we like buying stocks where you get a lot for the money
and selling stocks where you don't. Each of us brings
a different set of skills and experiences to the task.
Peter Tasker has worked as a strategist in Japan for over
twenty years and his deep knowledge of the market and
macro-economy provide a context for each of the stock-specific
decisions. Robert Macrae is a quant, providing tools that
assist in stock screenings, portfolio construction and
risk control and allow us to handle large and idiosyncratic
portfolios. Mark Pearson has worked since 1987 as a Japanese
fundamental analyst and fund manager and has an extensive
knowledge of Japanese companies. The stock-level knowledge
that he has built up over 17 years is a key part of our
At Arcus we work together to build and monitor portfolios
of undervalued longs and overvalued shorts, taking into
account the risk that each position brings to the portfolio,
our view on the company and its environment, and the risk
profile of the portfolio as a whole. This is the approach
we have followed for the last five and a half years.
- The Arcus Japan Long/Short Fund (AJLSF) and Arcus
Zensen Fund have a reputation of being focused mainly on
small/mid capitalisation stocks; why has the firm decided
to launch a hedge fund focusing almost exclusively on large
One of the reasons that we are known for small caps is
that this area has consistently generated the best stories.
That is where our 10-baggers come from, and that is where
the most exciting undiscovered gems are unearthed. Small-cap
stocks have certainly made a significant contribution
to returns, particularly over the last two years, but
these returns have been highly volatile. AJLSF and Zensen
have always invested in stocks of all market capitalisations,
and in fact over the five and a half year track record
of AJLSF large-cap stocks have actually contributed greater
returns than small caps. This performance attribution
suggests that the large-cap element of our trade should
now have a risk profile at least as good as that of our
I'd contrast the current situation with where we were
in August 2003 when we closed Zensen. Back then small
caps had made much less of a contribution, but we saw
great prospects for them - and that is also why we launched
the small/micro-cap Arcus Japan Value Fund a few months
later - but now the extreme valuation discount that we
saw for small and illiquid stocks has narrowed considerably
so prospects may not be so bright. It is often dangerous
to chase returns, and to us it looks like a good time
to focus somewhere else.
Since large-cap stocks in Japan and Asia are so well
covered by the major investment banks, what investment
insight can Arcus offer on these names?
We have run a large-cap long-only fund, Arcus Leaders
Fund, for four years and it has outperformed Topix by
79%, or 16% per annum. This and the performance attribution
suggest that we do have some edge in the large-cap universe.
However, it is still reasonable to ask how this can be
possible in what should be a relatively efficient market.
There is no single answer, but I would like to suggest
a. No area of the market is efficiently priced all
of the time. For example, the TMT bubble was a large-cap
phenomenon and represented the greatest mis-pricing
we have ever seen, and investment bank coverage did
little to improve the situation.
b. A contrarian approach that buys cheap stocks that
are out of favour and sells expensive stocks that are
currently fashionable should be profitable more often
than not, for large stocks as well as small stocks,
and there is a long history of academic work supporting
this idea. Of course there will be many months and some
years when the strategy does not work, but we think
the odds favour our approach.
c. Our knowledge of many companies in Japan may give
us an advantage even when we look at only the most liquid
stocks. When we want to make a decision on a large company
we will also have spoken to many of its smaller competitors,
suppliers and customers, providing a context that large-cap
only specialists may not have.
d. Many investors seem to approach companies with an
open mind, listen to what the company has to say and then
make a judgement based on what they hear. We are not like
that at all. We go in to companies with a clear preconception
one way or another about the company's potential attractions.
When we visit a company the choice is either "Buy
or Ignore?" or else it is "Sell or Ignore?"
and we have a list of questions we want answered. Unless
we already have a strong view we don't visit. If we leave
the meeting with ticks to all the items on our shopping
list, we trade; in other words we go in with a defined
objective and come out with a definite answer. This habit
is as applicable to the large companies as to the small,
and I think it makes us less susceptible to the stories
and fashions of the moment.
Arcus Investment is known as having a "value"
investment approach, which hurt in 1999. However, 2003
was a terrible year for value investors while Arcus Zensen
Fund was +31%, top quartile of Japan L/S equity funds.
Our strategy has always been to look for a variety of
different types of mis-valued stocks. For example on the
long side we seek exposure to a range of different kinds
of undervalued stocks - deep discount value stocks, net
nets, low P/Es, GARP ("Growth At Reasonable Prices")
stocks, undervalued new economy stocks, some quasi-distressed
companies and relatively undervalued major companies.
We are generalists, not specialists; at any point in time
we will be tilting exposures towards the areas that we
believe to be the most interesting.
For example during 2003 the fund profited from its exposure
to GARP stocks such as contents providers for mobile phones,
innovative restaurant chains and growing specialist retailers.
We also held quasi-distressed stocks in industries such
as real estate, retailing, steel, textiles and banking
- some of which used to be called "Zombies"
but are now "Pure-Play Japan Recovery Stocks".
These types of stocks would not necessarily have appeared
in a typical value index or portfolio but they certainly
met our criteria, having potential that was not in the
The 2003 bounce was a great time for our kind of value
because investors were looking at a real recovery and
seeking real opportunities. 1999 was about chasing dream
stocks; 2003 was about investing in companies with real
The Arcus Zenkei Fund can have up to 20% of its net
exposure outside of Japan. After focusing primarily on
Japan for the last ten plus years, what is your edge in
investing outside of Japan?
Japan has been our main focus at Arcus, but both Mark
and Robert have managed non-Japanese money. The approach
and tools we use in Japan have also been tested and used
overseas, and to understand Japan we already have to understand
other markets and companies in other countries.
Just as in Japan, our edge is that of the generalist.
Any specialist has a single area and must invest in it
come rain or shine, good times or bad. A generalist can
cherry pick, putting on positions just when the opportunity
is there. When we see potential investments overseas we
already have the option of including them in the Zensen
portfolio, and going forward we anticipate that foreign
positions will play an increasing - though still subordinate
- role in both funds. The focus will remain firmly on
- Can you explain how you will manage the fund's risk
and try to maintain annualised volatility of 10% or lower?
Zenkei will use the same risk control systems that we
use for all our existing funds. Our objective is to take
a large number of small bets, preferably uncorrelated.
In practice this means that we try to keep the exposure
to any particular stock or sector relatively small. We
also try to get exposure to a range of different types
of value. Before we trade we estimate the contribution
each position will make to risk, so that we can keep the
fund's expected volatility within its 10% budget. This
is a very conservative, broad-based, approach to portfolio
construction, which has two major benefits.
Firstly it avoids us having to be reactive. We don't
use stop losses at all, and we rarely feel obliged to
trade in reaction to market events. This lets us take
a considered approach, and perhaps make better decisions
because we are not under pressure from returns. It also
helps us control transaction costs.
Secondly it allows us to be much more aggressive on stock
selection. We can go into a position knowing that we might
take a 50% or 100% loss, provided the odds look favourable.
If we were running a fund that was more aggressive at
the portfolio level (say taking concentrated 10% positions)
I think we would have to play safe and be less aggressive
on the individual names. Playing safe is not calculated
to maximise returns.
In Zenkei we can keep the tracking error
between longs and shorts lower than for our other funds
because we don't have the hard-to-hedge small-cap longs,
so overall risk should be slightly lower than for Zensen.
For the Arcus Zenkei Fund, will your marketing efforts
focus on any specific type of investor and geographical
location? Are you looking to diversify your investor base
outside of those in the Arcus Zensen Fund?
The core investors for Zenkei are mainly existing Zensen
investors, but we are also open to new money. We aim to
maintain a diverse investor base, with classes for onshore
and offshore investors in US Dollars, Euros or Yen. As
with our other funds, Zenkei has early redemption penalties
aimed at protecting long-term investors and will not be
ideal for investors with a short-term perspective or for
those seeking Japan exposure with a substantial long bias.
It might also be worth mentioning another
aspect of our approach that may be unattractive to some
investors. Like any contrarian, we are betting that the
market is wrong and sometimes it will be right. We see
significant drawdowns as an inescapable part of the approach,
and given our track record a drawdown of 10% or more should
be expected at some stage.
- As contrarians, how do you view the consensus that
the Japanese economy has finally turned the corner from
a liquidity trap to sustainable growth?
We have seen a gradual improvement in the Japanese corporate
sector over the past several years with companies in general
becoming more focused on profitability and cash flow.
The strength of the global economic cycle has also allowed
companies to accelerate the repair of their balance sheets,
and companies are now more profitable than they have ever
been, even at the height of the bubble. So far so good.
On the other hand, it is not clear that Japan is yet
at a stage where domestic demand can support growth without
a supportive external environment. This is not guaranteed.
Coupled with intense investor interest in some of the
sectors associated with domestic reflation (for example
real estate, retail, banking and highly indebted companies),
this suggests that there is room for disappointment even
if progress continues at the moderate pace that we expect.
Bottom line is that, having been well positioned
for the recovery and having made considerable returns
on some of the beneficiaries, we are now concerned that
the pace of recovery may not match the market's high expectations.
On a five-year timescale we expect Japan to continue on
the road to recovery but that road is unlikely to be smooth.
We see plenty of opportunities on both sides of the market,
and suspect that a well-hedged approach may now be the
best way to benefit.
Arcus Investment Ltd
Tel: 44 20 7861 9661