The Interview - Michael Derks, Arch Financial Products: "This is a very opportune time to be invested in the private finance sector"
Michael Derks, chief investment officer of Arch Financial Products, says the CF Arch cru Finance Fund launched in November to invest in short- to medium-term private finance deals enjoys excellent prospects in a time of unprecedented financial and economic duress when traditional lenders do not have the appetite for loans of past years.
HW: What is the background to your company and fund?
MD: Arch Financial Products is a London-based investment management group providing a broad range of specialist asset management and structured investment products and services to both retail and institutional investors.
Arch was established in 2002 and now has more than 60 investment partners and staff, managing more than USD1.5bn billion of investments. Our funds have continued to generate excellent performance through the credit crunch and equity market downturn, principally through an emphasis on strategic private investments.
Arch is committed to delivering superior risk-adjusted performance and longevity. One of our hallmarks is the diversity of experience of the principals. Unusually for an investment management firm, Arch draws on a diverse range of skills ranging from traditional asset management, investment banking, alternative investments, private equity and structured finance, providing clients with coverage of a much wider range of investment strategies and asset types.
Arch runs six FSA-regulated Oeics including the recently-launched CF Arch cru Finance Fund, as well as a range of Guernsey-based institutional funds. The CF Arch cru Finance Fund, launched on November 11, aims to offer retail investors low-risk exposure to private markets and targets annual returns 2 per cent above the Bank of England base rate with annualised volatility of less than 3 per cent. Up to the end of December the fund returned 1.47 per cent.
The fund gains exposure to short- to medium-term private finance deals as part of a dynamic allocation strategy. The restricted credit in public markets and reduced willingness of banks to lend has seen the number of private finance deals soar in recent months. Arch capitalises on this by targeting a diverse range of specialist debt investments.
Arch acts as investment manager to the fund, while cru has responsibility for retail distribution. The fund offers an alternative to fixed interest investment and is available in sterling with a minimum investment of GBP1,000.
HW: Who are the fund's service providers?
MD: The authorised corporate director is Capita Financial Managers, the custodian and depositary is HSBC Bank, and the auditor is Ernst & Young.
HW: How and where do you distribute the funds? What is the profile of your client base?
MD: For the UK funds, distribution is principally carried out through the independent financial adviser marketplace and associated investment platforms. The client base is almost exclusively UK retail and high net worth investors.
HW: What is your investment process?
MD: The investment process is very much top-down in terms of strategic asset allocation. By not limiting the process by asset class or market focus, we take a holistic view across all investment alternatives, whether direct, third-party, derivative or synthetic in nature.
Arch targets risk-adjusted return as value and cyclical risk is also very important. We seek to enter strategies when there is inefficiency or limited competition, and thus excess return available on a like-for-like risk basis. Similarly we seek to exit strategies that are becoming crowded.
The investment process comprises two important elements, the set-up and ongoing management of investment and risk exposures, and the set-up and co-ordination of the appropriate pools of human capital to manage both the funds and the underlying investment assets and risks.
Arch builds teams and form co-operation arrangements as necessary to make more informed decisions about investment, asset management and risk. We believe it far better to manage a smaller number of investments with plenty of information to hand to make decisions rather than to have a hugely diversified exposure but know little about each investment.
Finally, the structured investment teams within the group assist the portfolio managers in terms of industry deal flow, contacts, expertise and risk management, often enabling us to structure additional risk protection for the portfolios.
HW: How do you generate ideas for your funds?
MD: The process of idea generation takes two essential forms. One is essentially top-down, in that it drops out of a considered appraisal of the financial and macroeconomic environment. The other is more hands-on or bottom-up, in that the extensive experience and contacts of Arch partners and employees generates interesting, sometimes opportunistic deal flow.
Often these two approaches complement each other, in that a top-down view will direct the energies of those individuals involved in deal flow, while consideration of specific deals may well nuance and inform our macro view.
HW: What is your approach to managing risk?
MD: Effective downside risk management is the key to sustained returns over the medium to long term. By avoiding public markets at key times, we have been able to avoid large losses caused by market beta. Our approach to risk is heuristic and forward-looking, combined with a systematic approach using in-house quantitative systems.
Risks can be broken down into market-related risks (market beta, or more generally asset class beta), asset and fund-related operational risks, legal and due diligence-type risks, and credit, cash flow and liquidity risks
Arch has invested considerable time and resources in its risk systems, which enable us to monitor and scenario-test an extremely broad range of investments, either in isolation or as part of a portfolio. The systems enable better attribution and understanding of sources of risk through techniques such as risk factorisation, relative omega, peer group and qualitative analysis and ranking. Using these systems Arch is able to manage both market beta and more general risk overlays.
At the operational level, Arch performs a full daily reconciliation on cash, trading and position exposures for all portfolios. Compliance with set limits is performed both in real time and as part of the daily valuation and exposure reporting process. Overall allocation policy and approvals are determined by the two investment committees; Arch has an investment committee that manages the multi-asset funds, and a separate investment committee for Guernsey fund activity.
At individual asset level, Arch employs teams of asset specialists who conduct initial and ongoing due diligence to assess the suitability of any investment, whether direct or via a third party partner or manager. Arch is continually reviewing its underlying investments from an expected risk and return perspective.
As an investment firm with a strong structuring pedigree, Arch actively seeks new methods for removing or mitigating risks, such as liquidity, legal and credit. Liquidity remains the key driver of investment risk and return at the present time.
HW: How do you expect your performance to evolve going forward?
MD: For 2009, returns are generally expected to be lower than in previous years due to the deflationary macro environment, lower returns on real assets, and the plunge in the risk-free rate, which ultimately sets the benchmark for all private finance deals. All but one of our onshore funds generated a positive return in 2008. The investment focus remains strategic, in that we aim to obtain the best combination of risk and reward, but with a bias towards senior and asset-backed security.
HW: What opportunities are you looking at right now?
MD: The remit for the CF Arch cru Finance Fund is to look for investments in the private finance sector. At this stage of the credit cycle, it is a very opportune time to be invested in this strategy, as collateral values have fallen substantially and traditional lenders do not have the appetite for loans that has been evident in recent years.
The key to success is to identify all of the potential risks with any loan. Particular attention needs to be paid at this time to both counterparty risk and delivery risk. The range of opportunities is considerable in a time of unprecedented financial and economic duress. As with private equity, the 2009 vintage for private finance has excellent prospects.
HW: What developments do you anticipate in your sector in the year ahead?
MD: During this period of poor returns and very uncertain future prospects for traditional public asset classes, we expect investors to increasingly look for alternatives to the well-worn path of listed securities. Private finance offers an interesting alternative, especially during this phase of the credit cycle where banks are rationing credit to firms of all sizes and business owners are often desperate for funding for working capital.
Also, with asset prices generally under downward pressure, it remains imperative for any manager operating in this space to ensure that collateral is conservatively valued and reasonably liquid, in case there should be a default.
HW: How will these developments affect your own portfolio?
MD: We are very excited by the range and quality of the opportunities presented to us at this time. We sense that this is an excellent environment for this strategy, although extra caution will need to be exercised during this very punishing phase of the credit cycle.
HW: What differentiates you from other managers in your sector?
MD: Arch is a privately-owned independent institutional fund management company with a fund range that provides retail and high net worth clients with access to the attractive risk-adjusted returns that can be earned in private markets. We offer a dynamic mixture of investment banking and fund management expertise, a contrarian forward-looking risk management, and recognition of the often poor value in public markets.
HW: Do you have any plans for other product launches in the near future?
MD: A multitude of investment opportunities are presenting themselves across all traditional and non-traditional asset classes. We have a number of new product initiatives in the pipeline, and shall make those initiatives public at the appropriate time.
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