9 November 2016, Sweden | News
It is now a testing time for quality companies, those that demonstrate strong growth year after year. Any belief that interest rates will fall further has gone and, in a world economy that is not growing, even the best fast-growers will have a tough time.
This is one of the conclusions Martin Nilsson and Ola Mårtensson have reached this year. The duo manages the Catella Nordic Long Short Equity hedge fund, which has risen 9 percent year to date – more than the stock market.
At the beginning of the year the fund was down about 5-6 percent, but since the summer the returns have been all the better. From having been invested in long positions in many mid-sized companies, often with large Swedish exposure, and having short positions in emerging markets, metals and industrials, the fund turned on his heel at the beginning of the year.
"This is a strategy that had worked since the financial crisis – owning growth and being short in value companies. But we realised early in the year that it would no longer work," says Martin Nilsson in a podcast from Catella Fonder.
Both portfolio managers say that the key indicator was the interest rate. It was no longer possible to focus on transactions that assume falling interest rates. And growth companies have started to meet problems in an environment that is no longer growing.
"Their organic growth is no longer 8-10 percent, but perhaps 1-2 percent, and so you really don't want to pay p/e 35. A good example of a company we have shorted is Novozymes, which recently dropped another 12 percent on its report. It cut its next-quarter outlook for the third consecutive quarter. Its valuation is no longer p/e 35 but 25, but this is still too high for a company that is actually not growing anymore," continues Martin Nilsson.
Ola Mårtensson points out that there are naturally more sectors than just pharmaceuticals being impacted by long-term interest rates no longer decreasing. He has one sector particularly in mind.
"Property. Things start happening even if interest rates are simply not falling. Real estate companies are certainly losers from higher long-term interest rates," he says.
However, one particular category that is recovering is what is known as value stocks; stable, 'dull' companies that are not sensitive to economic cycles, with low valuations and steady dividends. This is investment legend Warren Buffett's favourite category, and also a category that has been outdated and out of fashion ever since the financial crisis began in 2007.
Martin Nilsson takes a forestry company as one example.
"Holmen started to do really well when SCA announced it would split its business into two parts. But this also coincided with the worldwide interest-rate trend," he says.
The way the fund's two managers divide up their work is for Martin Nilsson to manage the long holdings, chosen mainly on fundamental analysis, while Ola Mårtensson manages the fund's short holdings, which he picks mainly using quantitative selection methods.
"We look at companies with rising earnings expectations. Then we look at the balance sheet and try to find anything wrong. You probably don't want to be short in companies with a strong balance sheet," says Ola Mårtensson.
Martin Nilsson's long holdings have previously been picked mainly in Denmark, which has had the world's strongest stock market since the financial crisis of 2007. However, since early 2016 the portfolio managers have chosen to short some Danish stocks.
"This exemplifies what we are talking about: quality companies with extremely high valuations. This year it has gone the other way and the largest company in Copenhagen is down 35 percent," he says, referring to diabetes giant Novo Nordisk.
As an example of a company that has long had a tough time, but has now turned, he mentions a very different sort of Danish enterprise: shipping titan Maersk, which has been one of the fund's largest long positions since the summer and has proved to be an excellent investment.
"The outlook for container shipping has improved for several reasons. Maersk has the lowest costs. Moreover, this has been the biggest scrapping year ever in the industry, with 4-5 percent of the fleet removed. If, like Maersk, you then have the lowest costs there is considerable leverage when rates improve," says Martin Nilsson.
Maersk also has a stake in the Johan Sverdrup oil field, which is otherwise mostly a concern for Norway, through Statoil and Aker, and for Sweden, through Lundin Petroleum. Johan Sverdrup can now be developed at a time when oil service prices are falling sharply, benefiting many Norwegian interests.
Another Norwegian story is fish farming.
"We have been long in Marine Harvest and Bakkafrost during the time I have worked with the fund. But right now we have no positions in the sector, either long or short. Fundamentally it still looks very good," says Ola Mårtensson.
As for our third neighbour, Finland has long been suffering from weak sales to Eastern Europe and Russia, but this has recently improved.
"After five difficult years Finland has started to improve, and this is becoming apparent in the construction sector. Mining is one area that has particularly started to see growth," continues Ola Mårtensson.
Back home in Sweden, Martin Nilsson mentions the financial sector as the best performer since the summer, and where the latest reports looked good. Sales are a big question mark for industrials, with plenty of examples of negative organic growth.
For the coming 12 months, the portfolio managers have a negative view of the Stockholm stock exchange, which has risen several percent this year.
"We are approaching a time when we will certainly see a large downward correction. The interim reports were not great and the valuation is quite stretched," says Martin Nilsson.
"Two recent changes are, on the long side, in oil services, a sector that has been totally bombed out, and on the short side several Swedish property companies, which have also been good in the short run," says Ola Mårtensson.
Important Information
Investments in fund units are associated with risk. Past performance is no guarantee of future returns. The money invested in a fund can increase and decrease in value and it is not certain that you will get back the full amount invested. No consideration is given to inflation. The Catella Balanserad, Catella Credit Opportunity and Catella Hedgefond funds are special funds under the Swedish Alternative Investment Fund Managers Act (SFS 2013:561) (AIFM). Catella Reavinstfond and Catella Småbolagsfond may use derivatives, and the value of the funds may vary significantly over time. The value of Catella Sverige Index may vary significantly over time. Catella Avkastningsfond may use derivatives and may have a larger proportion of the fund invested in bonds and other debt instruments issued by individual national and local authorities and within the EEA than other mutual funds, in accordance with Chapter 5, Article 8 of the Swedish Investment Funds Act (SFS 2004:46). Catella Nordic Long Short Equity and Catella Nordic Corporate Bond Flex may use derivatives and may have a greater proportion of the funds invested in bonds and other debt instruments issued by individual national and local authorities and within the EEA than other mutual funds. For more details, complete prospectuses, key investor information, and annual and half-yearly reports, please refer to our website at catella.se/fonder or phone +46 8 614 25 00.
