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Asia Pacific Intelligence

Dutch investment boutique hunts for returns in Japan's revitalisation

Tuesday, April 09, 2013

Michael Kretschmer

Michael Kretschmer is co-manager of the Netherlands based Pelargos Japan Alpha Fund, from investment boutique Pelargos Capital. The fund launched in June 2008, has returned 35% since inception, and has $135m under management, most of which is from the Dutch insurance company Aegon. His co-manager is Richard Dingemans. The Aegon connection came from their decision to do an alpha/beta split in their asset management with the bulk of their money under management going into beta funds such as ETFs while a small proportion went into alpha, specifically into long/short vehicles such as the Asian and Japan fund run by Pelargos.

The fund's strategy is long/short relative value, with Kretschmer buying cheap equities and shorting the expensive ones. While 2008 was a tough time to start a fund, Kretschmer feels, with the benefit of hindsight, that it was a fortunate time to launch. "In the middle of the crisis, we could start from scratch" he says, allowing a pure focus on performance while marketing was a bit more tricky.

The fund is designed to be net long or net short in a range between minus 25 to plus 60 and Kretschmer likes to keep a close eye on volatility, targeting high single digit volatility. The realized volatility stands at 6.5% whilst the current ex-ante volatility is close to 10%. "Because it's a moving target, it's difficult to target" he says, "and we are very risk conscious but in Japan we currently wanted to be aggressive and carry risk in the books because lots of things have changed in Japan."

As the situation in Japan changes, Kretschmer sees it move from a volatile environment to a momentum market. "There are two ways to look at it" he says. "Yen sensitive stocks have done extremely well out-performing the majority of other markets because the yen was weak but that trade is over so now we look at the domestic space and reflation stocks."

Kretschmer believes that the domestic Japan story bears a lot of opportunity, with cheap domestic stocks hitting a wall of consumption drivers.

"It is extremely exciting after a 20 year bear market and deflation - assets are cheap, food is cheap and housing affordable. You can buy good companies for low prices and as the deflation trade is switching and the whole economy transitioning from deflation to inflation and you can make a lot of money with risk assets like equities."

The first off the blocks are the highly leveraged stocks, particularly real estate developers with a lot of land and debt on their balance sheet.

The Netherlands base for the fund means that the fund is more analytical than event driven. The fund managers visit companies and their management teams every quarter with one week of meetings.

The recent rise in investment return from Japanese hedge funds has caused observers to worry about a bubble scenario. Kretschmer believes that the current effects of the Bank of Japan policies will leave a wealth effect that is temporary, rather than structural. "Even if they achieve the stated 2% inflation target this is just a redistribution of wealth within society which used to benefit older people and might now benefit younger people who tend to spend more and take more risk but I am doubtful potential real GDP will actually benefit" he says.

The lower yen is a real boost as it means potentially higher corporate earnings, thereby higher capital expenditure and eventually more consumer spending. Within its current monetary policy mandate, the Bank of Japan has bought equities to try and encourage a return to inflation. This has particularly worked with REITs which have caused real estate inflation to return to the sector.

"Inflation and higher risk assets will make structural reforms easier to execute and that, in contrast to just money printing, could boost the potential GDP but it's a bit too early to assess that" Kretschmer says. "As the Bank of Japan continues to buy equities it is rational to go along especially because equities are still inexpensive. It's a natural thing. You see a similar phenomenon in US equities with the Bernanke put and in peripheral European fixed income with the Draghi put."

Within the last two to three months the fund has begun to attract the attention of other institutional investors, both globally and from Japan itself. "It is well suited to institutions and over the past few years overseas domiciled Japan manager performed better than Japanese fund managers themselves" Kretschmer says.

Institutions like the single digit volatility target. Performance has been steady since the outset. The worst month came in May 2012 when a little early reflation bubble in Japanese equities burst and the fund dropped 3.8% but it ended up 11%, making money every single month after the drawdown.

Michael Kretschmer was a speaker at the Opalesque Netherlands Roundtable. You can read that here.

This article was published in Opalesque's Asia Pacific Intelligence our monthly research update on alternative investments in the Asia-Pacific region.
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