The Interview – Ralph Nacey and Eric Phillipps, WestSpring Advisors: “Sound credit strategies should outperform equities over the medium term”

WestSpring Advisors principals Ralph Nacey (pictured) and Eric Phillipps, who launched the FRM-backed firm’s first family of fixed-income funds last month, believe that the current corrective deleveraging phase during which the excesses of the past cycle are being worked off will continue for at least several years.

GFM: What is the background to your company and fund?

RN/EP: WestSpring Advisors was founded to manage fixed-income strategies by Ralph Nacey and Eric Phillipps, who have worked closely together since 2002. We began managing fixed income assets with a long/short proprietary trading portfolio for Merrill Lynch and later founded Brigadier Capital Management, a subsidiary of Cohen & Company, where we generated superior risk adjusted returns between June 2006 and February this year.

We formed WestSpring Advisors with an initial investment of between USD40m and USD60m from FRM Capital Advisors Guernsey, a member of the Financial Risk Management group. With this capital and that of other limited partners, WestSpring launched the WestSpring Master Fund, WestSpring Fund Ltd and WestSpring Fund LP on October 1. WestSpring has augmented its core investment staff of Ralph, Eric, Tom Hu, and Joe Hogan from Brigadier with Michael Manley and Ryan Lim.

Ralph, who was chief investment officer of Brigadier, previously built a North American derivatives structuring desk at Merrill Lynch and subsequently headed a long/short proprietary trading business that focused on corporate credit and structured finance. Earlier he worked on M&A, debt and equity offerings in the investment banking division at Credit Suisse First Boston and was also a lead structurer working on new products in the North American structured credit products group.

Eric, a portfolio manager at Brigadier, had been the lead trader at the Merrill Lynch long/short corporate credit and structured finance proprietary trading business and a lead structurer in Merrill’s global structured credit products group, responsible for structuring and determining hedge strategies for various credit products. Earlier he worked with both cash and synthetic products in the North American structured credit products group at CSFB.

GFM: Who are your key service providers?

RN/EP: Our US counsel is Schulte Roth & Zabel and our Cayman counsel Maples and Calder. Our auditor is PricewaterhouseCoopers, our administrator is HedgeServ and our custodian JPMorgan Chase.

GFM: What is the profile of your current and targeted client base?

RN/EP: WestSpring is in discussions with prior and prospective institutional investors. We are focusing our fundraising activity on institutions, but will complement that with private clients, primarily through private bank platforms.

GFM: What is your investment process?

RN/EP: New positions are comprehensively researched and then sized to a predetermined risk exposure limit, then return target. Approval from both principals is required to commit capital; either principal can veto an investment. WestSpring assembles a full credit write-up for reference and discussion of a trade throughout the life of the investment. The trade must then pass risk requirements and return objectives, in that order.

GFM: How do you generate ideas for your funds?

RN/EP: Ideas are generally developed and vetted as a result of the firm’s microeconomic analytic research. All investment professionals are encouraged to present ideas to the investment committee, which consists of the two principals. The portfolio will generally consist of between 30 and 50 investments.

GFM: What is your approach to managing risk?

RN/EP: The risk checks include the primary risk components of maximum exposure credit risk, market price risk and liquidity risk. Additionally, the trade must pass firm limits for systemic risks, such as counterparty risk and market dislocation risk. Passing requirements include trade level and portfolio level limits.

If risk filters are in accordance with policy, then the trade’s potential profit is further analysed. Our general targets are 15-20 per cent for relative value (downside 5 per cent); 20-30 per cent for directional alpha (downside 5 per cent); 30 per cent for cheap optionality (downside 2 per cent); and 10-15 per cent for ballast trade (downside 10 per cent). Risk limits are closely adhered to, whereas return targets are guidelines, dependent upon market considerations.

GFM: How has your recent performance compared with your expectations and track record?

RN/EP: Between June 2006 and February this year, we generated risk-adjusted returns for Brigadier that were slightly better than our expectations. Over this period, the fund we managed with other team members returned 23.6 per cent net on an annualised basis, with a monthly standard deviation of 2.23 per cent and Sharpe ratio of 2.6. These returns demonstrated low correlations of -0.036, 0.17, and 0.01 to the Merrill Lynch High Yield Master II, MSCI Long-Short Credit Index and S&P 500 respectively.

GFM: What opportunities are you looking at right now?

RN/EP: We believe the events of the past few years and the turn in the credit cycle have increased market opportunities significantly. Right now, we are of the view that there is more uncertainty about the fundamental value of assets than there has been in quite some time. WestSpring looks to focus on sectors where we believe that this is most apparent and use our data-driven, fundamental analysis and trade construction to exploit attractive market opportunities.

We can highlight two broad opportunity categories. First is investment in markets where there has been a recent reduction in the number of market participants, areas such as senior corporate financing, housing-related industries, and parts of the credit default swap markets. Second is trades related to continued credit deleveraging and those areas most affected by it, such as trades surrounding corporate solvency issues and those involving companies that may need to access the capital markets in the near term.

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

RN/EP: The corrective deleveraging phase in which we now find ourselves, to work off the excesses of the past cycle, is one that should take at least several years and we believe will provide ample opportunities for a credit strategy, such as ours, along the way.

GFM: How will these developments affect your own portfolio?

RN/EP: We endeavour to manage our portfolio in a manner that should take advantage of continued deleveraging and believe that sound credit strategies should outperform equities over the medium term.

GFM: Are investors’ expectations shifting between capital preservation and growth? If so, how do you deal with this?

RN/EP: We do see investor sentiment shifting. These new expectations are actually more in line with the way we at WestSpring have always approached managing our clients’ assets, so we view this shift as a positive one. We believe the primary responsibility of a manager is to focus on preserving the assets of investors and then to seek to grow those assets, within the established risk framework, as much as possible.

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

RN/EP: We have a proven track record of developing an information advantage through proprietary analytic techniques to understand better microeconomic trends and their linkage to fundamental credit analysis.

We employ our deliberate trade construction and market trading experience to maximise potential investment reward for established risk parameters. Our risk management system is based on a proprietary exposure framework that contemplates maximum potential loss, and analysis is integrated with the portfolio management process of sizing risk positions.

Finally, our new portfolio will take advantage of current value in liquid asset markets without legacy issues.

GFM: How do you view the environment for fundraising?

RN/EP: We trust that the market will reward consistent performance and will take note of funds that managed liquidity through the market’s most recent test of both of these principles of sound investing.

GFM: Given the talk of further consolidation in the industry, are you planning any mergers or acquisitions this year?

RN/EP: We are not. We are taking the contrarian approach of increasing our independence, reflected in our move to start WestSpring. We are quite pleased with the opportunities the current employment and other markets have provided our firm. The low-growth environment has facilitated our efforts to attract talent and to enter into more balanced agreements with market-leading business partners.



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