Gains in a falling market!

The hedge fund has had a positive return – it is positioned to ensure no market risk at the moment, and this means a significant short element to the portfolio, thus making a positive contribution to the returns as the stock market has fallen. The fixed income side has continued to make money, although the managers are especially pleased that the long side of the portfolio, which might have been expected to follow the stock market downward, provided a reasonable positive contribution.

The fund has gained around 3 percent since the start of the year, and during the summer it increased in value while the stock market fell back 6-7 percent.

This means that you have created something that is uncorrelated with the market. How did you do that?

"There was a period at the beginning of the year when we earned money and when the stock market mainly rose, and this summer we have earned money as the stock market has fallen. When we took over as a partly new team in the autumn and reworked the fund, our focus was to create uncorrelated returns, with the fund uncorrelated with the stock market," says Martin Jonsson in a podcast for Catella Fonder.

He explains that this means the stock market should not be the main variable governing performance.

"Most hedge funds have quite high correlation with the stock market, so maybe 60-70 percent of the results are explained by market performance. We do not think it should be like this – stock picking should be more important. What we have done is to replace the market risk with company risk," continues Martin Jonsson.

You have also broadened the portfolio and have maybe 2 percent in the largest individual holding, while most are around 1 percent. The diversification has increased.

"There was a conscious decision to obtain greater diversification in order to better manage portfolio risk. We have been successful with it this year; looking at the long side of the portfolio we actually have very few loss-making positions," says Martin Jonsson.

The hedge fund's fixed income element is fairly large, consisting of a combination of active interest rate management and cash management. Since the equity side has a fairly low net, it does not draw much capital – leaving quite a lot of cash to take care of.

"The equity side does not generally consume very much capital and it therefore ends up with us, on the fixed income side, to manage. The fund is traded daily, which means we have to make sure there is plenty of liquidity to meet client requirements, and capacity for new investments. Since we have chosen to hold a relatively high proportion of corporate bonds rather than government bonds, liquidity is significantly less, which is another reason why we have to hold a high level of liquidity," says Thomas Elofsson.

You are able to invest in anything included in the concept of fixed income, but right now you have quite a lot of corporate bonds and cash – is it mostly mortgage bonds at the moment?

"It's a mix of triple-A mortgage bonds, some government bonds and some commercial paper," says Stefan Wigstrand.

This has been a fairly good period for credits, and spreads have narrowed considerably, which has benefitted the hedge fund.

"An invested portfolio benefits from a trend like this. And on top of this we have obviously had price gains for a lot of bonds. Looking at the market as a whole, the spreads are low, not to mention total yield which on the high-yield market in Europe is probably the lowest ever. Spreads are back to about where they were 10 years ago, before the financial crisis. Clearly we should be observant in a situation like this, and we have chosen to reduce our risk towards a large number of high-yield corporate bonds – quite simply, we have taken some profits," says Stefan Wigstrand.

The fixed income managers have three fixed income funds under their stewardship, and all three have experienced strong performance, not least so far this year.

"The things we like are typically structures that could offer some upside if companies are sold or join the stock market – this makes it possible to achieve turns similar to equities. It's been a combination of luck and skill, but we had a vision at the start of the year that, with interest rates so very low and with a reasonable economy, this was the best of all markets for this kind of asset," says Thomas Elofsson.

The ultimate consequence for you as a lender is that the company goes bankrupt, which mainly happens when the economy is really bad. Surely we're not at that point yet?

"No, that's not really what we envisage," says Thomas Elofsson.

The latest data has been a little stronger than expected.

"Growth is being revised upward and expectations are getting higher globally. The critical factor for all assets will be whether growth is much better than expected, which means we will have to try to find companies that can do well in this kind of environment. Conversely, if growth is much weaker we will also have to find companies that do well," says Thomas Elofsson.

The US market has slowed somewhat after equities surged for a while. However, Swedish shares have developed at their own pace with a couple of strong quarters.

"Looking at the slightly longer perspective, the US has been driven upward by only a small number of companies; a few giants, mainly in the tech sector. If we then look at the Nordic market in the rear-view mirror, the fourth quarter was really good for businesses, leading analysts to raise their expectations ahead of the first quarter – which turned out fantastically well. A large number of companies beat expectations and share prices rose quite sharply. Predictions were then upped again ahead of the second quarter, which I would say came in line with expectations. This was not enough for share prices to continue their gains," says Martin Nilsson, while Martin Jonsson points to the importance of exchange rates.

"Earnings estimates have actually risen in the US thanks to the weak dollar. This has assisted the American stock market while there has been a corresponding headwind in Europe, and particularly in Stockholm where earnings were revised downward," he says.

Commodities have picked up a lot recently.

"Oil prices have now risen, although at this very moment they have backed away due to Hurricane Harvey causing a large proportion of US refineries to close. Metals have done really well, for many reasons. The three most important, I believe, are stronger Chinese growth, the weaker dollar and speculative interest," says Martin Nilsson

Have you benefited from this?

"We certainly have. There were long positions among our holdings that definitely benefitted from rising commodity prices," continues Martin Nilsson, who highlights Finnish Outokumpu as one example. This company makes stainless steel and benefits from a rising nickel price since it drives up the price of stainless steel.

Employment has increased in both the United States and Sweden, and in many sectors it is difficult to find labour. Will the rate of inflation rise now?

"Historically it has been the case that when the labour market tightens up and most people are in work wages typically start to rise, and companies offset this by pushing up their prices a little. This time has been surprising; even though the labour market is fairly tight, not much is happening with wages and even less with prices. But inflation also depends on how you measure it; some things, like food, are certainly becoming more expensive. Housing has risen quite a lot, as have assets in general. And then there are things that pull the figures down, like electronics and clothing," says Thomas Elofsson.

Tell us about some of the holdings in the portfolio.

One of the companies on the equity side of the portfolio is Storebrand, an investment the fund managers are very happy about.

"Storebrand is one of the best investments we have made. It is a Norwegian insurance company – not property insurance, but more other products. When we invested it was trading at a price in relation to book value of approximately 0.4. This is now approaching 1, and the return on investment has been more than 100 percent. Despite this we still think it is attractively valued in relation to other financial stocks," says Martin Nilsson.

Martin Jonsson highlights care company Ambea.

"Ambea has a very strong pipeline in care for the elderly. It is building its own homes that will generate growth in 2018-2020. The company is well-run and has good management, and we believe it will be able to grow by around 8 percent for a number of years, while it is valued at 14-15 times earnings," he says.

The hedge fund managers also like Electrolux. This stock has been included for quite a while as a long position, justified by a series of new product launches anticipated going forward that are expected to strengthen its price/mix.

How about on the short side?

"JM is a good example of where we have locked in a profit after only a short time. It shows something of the importance of getting out and about: I went to a large number of viewings in the spring and it was obvious that the market was anything but hot. JM's valuation looks quite attractive, but we shouldn't forget that when there is a real setback in this sector, from a recession, the share normally loses 80-90 percent. This is not where we're at right now, but what is happening, especially in Stockholm and also in other parts of Sweden, is excess supply, while there is a large difference between buyers and sellers, making the market cautious. I would not say it's a crash, especially given the low interest rates, but it is more difficult to sell out there. Construction starts will slow, which is one of the biggest drivers for JM, so we shorted this share at 315 kronor before the summer," says Martin Nilsson.

In summary, we can say that Catella Hedgefond has managed to achieve less correlation with the market and a positive return even in a negative environment. Thanks to increased risk focus, diversification into many sectors, good picking of short stocks and strong fixed income management, it has managed to provide a relatively high returns in relation to the level of risk.