The fund that bucked the trend

The most important factor in the market right now is the performance of China. Few, if any, observers outside China wholeheartedly believe in the official figures from the country, and the question is how far the statistics vary from reality. This uncertainty means that all investments in which China has a major or dominant role are being avoided by many investors.

Martin Nilsson and Ola Mårtensson share this concern.

"We are probably in agreement that, going forward, China will have unprecedented opportunities in specific industries and niches, but not in those that have driven China for the past 15-20 years. There will be a different kind of growth, perhaps more consumer-driven. There will be tremendous opportunities for many companies in China, but right now things will become tougher for large industrial entities that have classically done very well in China," says Martin.

He also highlights another trend: the recent substantial difference in the performance of large and small companies. Smaller companies have generally weathered the turbulence better, and one reason may be that they are often driven more by domestic sales.

Despite the trend of small companies seeming to perform better, this is not a decisive factor when the fund managers choose which shares to buy or to short sell (in the hope of a price decline).

"Actually, we ignore the size of the company. However, we have been seeking out companies with strong domestic or Nordic exposure, rather than exposure to emerging markets, and these tend to be slightly smaller businesses, "says Martin.

Before Martin and Ola took over the fund in May this year, they were engaged in different areas. Martin has worked at Nordea for much of his career, with research and asset management, and at Alecta. Ola has worked at Catella since 2003, occupied in areas such as the management of fund-of-fund assignments and the construction of model portfolios for Catella's wealth management activities.

The objective of the fund is to create a good, uncorrelated risk-adjusted return that also functions when the stock market is weak. When Martin and Ola took over the management, they decided to avoid major market exposures and to instead allow company picks – for both long and short positions – to be the decisive factor.

The fund management is shared, so that Martin has primary responsibility for the long positions while Ola mainly manages the short ones, although all investment decisions are taken jointly. The biggest change under the fund's new management relates to short positions – having previously hedged long positions with mainly index futures, the short positions are now dominated by individual companies. In addition, the fund has been broadened, with an increase in the number of holdings from 11 to 21 on the long side and from three to 17 on the short side.

Ola makes regular use of quantitative methods when selecting candidates for short positions. Over time, he has developed a number of models, based on available data, which can reveal companies that are expensive or that have strained balance sheets. The managers search through the Nordic stock universe for companies that in some way "come out very poorly" when the figures are analysed.

However, classic metrics such as the PE ratio (price/earnings per share) or the PB ratio (price/book value) are not something that Ola considers.

"Neither the PE ratio nor the PB ratio seem to work if you test them in hindsight. We look at other indicators, how the market has behaved and how the income statement and balance sheet have behaved," he says.

A clear pattern right now is that the models do not like companies that are commodity-exposed or that are exposed to emerging markets. Not because the models have been directed to seek out commodities or emerging markets, but quite simply because this is the result when the models are run.

If we look at the proportion of sales that the fund's companies have in different regions, the differences are striking between the stocks that make up the long and the short positions. Among the long positions, sales in the Nordics are around 46 percent, while emerging markets account for only 14 percent (23 September 2015). Among the companies in which the fund has short positions, sales to emerging markets are 39 percent (23 September 2015).

"We are short, for example, in Lundin Petroleum and have been since SEK 140. We are also short in Millicom and SSAB. Other companies that do not have any direct exposure to commodities or emerging markets also appear," says Ola.

Martin emphasises that he and Ola have two different approaches: while Ola has a background in quantitative analysis, Martin leans towards fundamental analysis.

"The quantitative person looks at shares historically, while the fundamental person looks more forward. When we select equities on both the long side and the short side, the holdings we arrive at are filtered through the opposite model. If our quantitative model says that we should not own something, then we don't do it. Similarly, if my fundamental model says that we should not be short in something, then we are not," says Martin.

The fund's long holdings have been successful, even recently, despite the stock market decline, and this has meant that we have made money on both the short side and the long side. In terms of net exposure right now, long holdings minus short holdings, the fund is net long by 17 percent (23 September 2015).

"What I look for in a long candidate is a company that that can drive its own growth, has an independence in some way and is not entirely dependent on what happens in a global cycle. And then we find diversification so that there are companies that are driven by different factors," says Martin.

The successful long holdings include Saab, which has managed to rise during a period when the Nordic stock markets have declined sharply. The company is in a positive cycle, according to Martin.

"Developments in Russia have caused countries around the world to realise that their defence spending may have been on the low side. The company has an order book right now of almost SEK 110 billion – extremely high historically. This is mainly because of the order from Brazil, but other orders are arriving almost daily from various countries," he says.

Another winner in terms of share price has been Evolution Gaming, which provides solutions for live casinos. Its share price has almost doubled in a couple of months.

"This is a growth stock in a growth industry, and with the prevailing interest rates globally it is generally difficult to find any growth. In the second quarter, sales for Evolution Gaming grew by 55 percent and EBITDA (earnings before interest, taxes, depreciation, amortisation and impairment) grew by over 80 percent. When you issue these kinds of numbers, which amazingly beat all expectations, the share price performance is very good," says Martin.

High-tech Mycronic, which manufactures laser mask writers for the production of printed circuit boards, has been in the fund for a long time and has contributed through a sharp rise in its share price. The share has lost some ground more recently, but the long position has been retained. The company's equipment is expensive, making each individual order important. Martin points out that Mycronic's new orders appear very strong.

"Following the summer, there have been orders for old equipment to be replaced with new equipment. I was asked by a sell-side analyst whether Mycronic has the capacity to take in more equipment, and posed the question to the company. They confirmed that this is not a problem," he says.

Finnish Cramo, which leases equipment, primarily for construction, is another company that has made a positive contribution among the long positions. Although the company is Finnish, most of its sales are in Sweden, making the visibility good when evaluating its performance.

Catella Nordic Long Short Equity typically has low correlation with the stock market overall. Viewed over a longer period of time, it is desirable that this remains the case, according to the managers. They are not particularly upbeat about stock market performance going forward – but nor are they obviously downbeat.

"When we started our collaboration in May, and looked at the models Ola has used for a long time, we mainly came up with short candidates. But we should note that the stock market was overvalued at that time. Right now, I would say that the models are fairly neutral, with a similar number of buy and sell candidates. If the models work, as we claim they do, the stock market is realistically valued right now," says Martin.

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