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The Hedgeweek Interview: Peter Nicholas, CIO, EN Asset Management: Stress-testing through a 9/11 scenario

Peter Nicholas outlines the investment strategy and processes that drive EN Asset Management's Japan-focused fund.

Peter Nicholas has been managing EN Benten Japan Fund since its launch in 2001 as Chief Investment Officer of the firm.  Peter has been following the Japanese equity market since 1980 and has been a portfolio manager for 21 years.  After graduating in economics from Bristol University, Peter worked on the sell side for four years before joining Warburg Investment Management.  He spent 12 years with Warburg, eight of which were spent working in Tokyo before leaving to join Henderson Global Investors. Peter left Henderson in 2001 to co-found EN Asset Management with Jon Easton.
HW: What is the background to the fund?

PN: EN Benten Japan Fund was launched in December 2001.  It has been managed throughout by Peter Nicholas, Chief Investment Officer of EN Asset Management, working since April 2005 with Zac Bharucha.  The fund reached peak assets of USD 250 million, following outstanding performance, but a low return in 2004 led to redemptions which have reduced the fund size to USD 20 million.  With a strong year for performance in 2005 behind us, we are now committed to rebuilding the Benten Fund's asset size.  In addition to the Benten Fund, the firm operates a small number of highly successful managed accounts. The current AUM are USD 320million, exclusively in Japan long/short equity strategies, so the finances of the business are very secure.

HW: How and where do you distribute the fund? What is your current and targeted client base?

PN: Jon Easton, co-founder and principal of the firm, is responsible for marketing. We target a wide range of hedge fund investors, including fund of funds, private banks, family offices, institutions in all regions.
HW: What is the investment process of your fund?

PN: The investment process is research based, fundamentally driven and predominantly bottom-up. Net exposure is maintained in a range of -20 / +50% with gross exposure of up to 150% of NAV. The Fund maintains between 50 and 75 positions. Trading decisions are made by the team in London. The team controls the fund's net and gross exposures, sector exposures and other factor exposures, as well as researching individual stocks. The London team is supported by three analysts working in our Tokyo office, who conduct in-depth research on individual companies, and maintain frequent contact with company managements and sell-side analysts.
HW: How do you generate ideas for your fund?

PN: Ideas are generated from a wide variety of sources.  We carry out frequent screenings of the whole market and individual sectors looking principally at valuation factors and earnings revisions.  We follow several hundred stock prices on a daily basis, keep in touch with a variety of news sources, and follow up information acquired in management meetings on competitors, suppliers and customers. 

HW: What is your approach to managing risk?

PN: We expect Fund volatility to be in the region of 8%. Our approach to managing risk is multi-faceted and includes the following elements:

At the inception of each position, a price target and a loss tolerance are determined.  Upside targets may be revised in the light of subsequent information and events, but loss limits are implemented strictly.

We maintain gross and net exposures within the limits mentioned above. 
Our portfolio is well diversified.  Long positions rarely exceed 3.5% of NAV and short positions 2.5%.  We avoid excessive sector concentration. We analyze liquidity risk continuously, maintaining a high level of overall portfolio liquidity and avoiding illiquid short positions. We analyze event risk, stress testing our portfolio using a 9/11 scenario and other 'four standard deviation events'. 

HW: How/against what do you benchmark the performance of your fund?

PN: Our return target is 10-15% net of all fees with controlled risk.  We monitor the performance of Topix and the Japanese equity long / short universe, but do not directly benchmark.  

HW: Has your performance been as per budget and expectations? Do you expect your performance or style to change going forward?

PN: The annualised return since inception has been over 10% and thus within expectations.  Going forward, we will maintain the same investment style and expect to take returns to nearer the high end of the 10-15% range. 

HW: What opportunities are you looking at right now?

PN: We see domestic reflation remaining the dominant theme in the market and continue to find related opportunities.  Technology stocks finished 2005 with a strong run and this continues in the early part of 2006, but we regard this as a more cyclical opportunity.  Overall, we think the fundamentals for the market in 2006 remain very good and combined with a strong technical picture, we expect another good year. 

HW: What events do you expect to see in your sector in the year ahead?

PN: We expect the economy to maintain a robust recovery and corporate earnings to continue to grow despite the probability of a cyclical slowdown in the United States.  We are likely to see the end of the Bank of Japan's zero interest rate policy and, in the autumn, the end of Mr. Koizumi's reign as prime minister. 

HW: How will these changes/future events impact on your own portfolio?

PN: If we are correct about the strength of the Japanese economy and stock market, changes in the portfolio will be evolutionary rather than radical.  The Bank of Japan is likely to flag the first interest rate rise well in advance to minimise market impact, and Koizumi's successor is likely to maintain current policies, so policy for the market is low. 

HW: What differentiates you from other managers in your sector?

PN: As a firm, we only manage Japanese equities in long/short strategies so we are completely focused on getting the strategy right.  The investment team is highly experienced, with average experience of the Japanese market over 20 years.  We are well represented by our office in Japan and have a broad network of contacts in the market and in corporate Japan. 

We have produced steady returns with controlled risk, compared with the generally high volatility of the Tokyo market.  Since inception we have had 33 up months to 16 down months, compared to Topix which has had 30 up months and 19 down months.  Our up months have averaged +1.7% (Topix +3.9%) and our down months -1.0% (Topix -3.5%).  Our maximum drawdown has been 5.5% with a nine week recovery time (Topix 29.6%, 44 weeks recovery). 

HW: Do you have any plans for similar/other product launches in the near future?
PN: Our first priority is to rebuild the Benten Fund's assets and we have no immediate plans for further launches.
(Peter Nicholas was Interviewed on 17 February 2006; the interview was revised on 17 May 2006)

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