FROM: Don Pierce, Chief Investment Officer
SUBJECT: Arrow Global - Master Custody Account
RECOMMENDATION:
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Recommend that the Board approve the establishment of a Master Custody Account (MCA) with Arrow Global, including a $175 million initial allocation, subject to completion of due diligence and legal documentation.
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BACKGROUND:
Starting in 2024 staff undertook an effort to broaden the portfolio’s capabilities in European credit. As previously communicated, this included an in-depth process to survey the market and identify target areas. Beginning with 62 survey respondents, staff conducted focused diligence on 10 managers and identified 4 managers that aligned with SBCERA’s objectives from a strategy and firm perspective.
Arrow Global (Arrow) was founded in 2005 by current CEO Zach Lewy. Arrow is a vertically integrated platform of loan servicing and asset management businesses operating in the U.K., Ireland, Netherlands, Germany, France, Italy, Spain, and Portugal. Across 24 platform companies, the firm oversees about €110 billion of assets. Staff and NEPC believe the platform gives Arrow sourcing and information advantages. Real estate is the most common collateral, but Arrow also has expertise in corporate loans to small companies, bankruptcy claims, mortgage portfolios, consumer, insurance claims, and specialty lending. The firm’s fund business has about €11 billion commitments and is run out of a centralized team in London. Arrow is currently majority owned by a private equity firm, TDR.
We believe Arrow’s platform is aligned with SBCERA’s portfolio objectives because they seek to buy assets at attractive valuations, have a focus on cash flow, and the platform has a unique ability to find and invest in opportunistic situations. We believe Arrow’s strategies are diversifying and can generate attractive risk adjusted returns for the SBCERA portfolio. We expect the portfolio net total return to be in the mid-teens range.
The MCA account is designed as a separate account to hold assets on behalf of SBCERA and access investments across the Arrow platform. Initially, a core component will replicate Arrow Credit Opportunities (ACO) III which will be paired with a direct investment sleeve.
- The ACO III replication will have an initial allocation of $125 million. The strategy of ACO III is to invest in credit portfolios and single names (40% to 60% allocation target), corporate bankruptcies & restructurings (25% to 35%), and secured collateral & value-add opportunities (15% to 25%). The core strategy is to buy single loans or pools of performing and non-performing loans, and create value by workout, refinance or repayment. Corporate bankruptcy & restructuring investments focus on specific jurisdictions where loans can attach to assets such as cash, real estate, or receivables that are temporarily stuck in the restructuring process. Secured collateral & value-add opportunities involves acquisition of real estate where Arrow believes they can increase the value by repositioning or improving operations. Portfolio managers will allocate to the best risk/reward across the total platform. Local sourcing focuses on proven strategies within each region.
- The direct investment component is initially sized at $50mm and all investments will be subject to staff discretion. Direct investments will be credit focused and draw from across the platform. Zach Lewy and Jay Patel will be responsible for sourcing, screening and providing recommendations to SBCERA.
NEPC has given the ACO III fund its strongest recommendation and they have a group of clients who are expected to invest in the fund. SBCERA has been able to negotiate a favorable fee structure that aligns with our portfolio objectives.
The recommendation for an Arrow Global MCA of $175 million would represent about 1.1% of plan assets and be included in SBCERA’s Global Fixed Income allocation. The current Board established target for the asset class is 17% of plan assets or about $2.7 billion. The current physical asset exposure is about $1.8 billion, or 11% of total assets. In total staff is recommending $775 million in commitments to new European Credit mandates. Once fully implemented, about 4.75% of plan assets would shift from the overlay to physical mandates. This would make total physical exposure about $2.56 billion or 15.7% of total plan assets. The overlay would continue to be employed to implement the Board approved asset allocation and informed rebalancing targets.
BUDGET IMPACT:
Investment Costs are deducted from Net Asset Value.
STRATEGIC PLANNING GOAL/OBJECTIVE:
Prudent Fiscal Management
STAFF CONTACT:
Jacob Abbott
ATTACHMENTS:
Exhibit A: Arrow Global Presentation
Exhibit B: NEPC Cover Memo
Exhibit C: NEPC Investment Due Diligence Report (confidential)
Exhibit D: NEPC Investment Memo (confidential)
Exhibit E: Additional Staff Information (confidential)