Success strategies
Since launching two strategy funds in 1999, ORN Capital has gone from strength to strength and is following up this success up with the launch of a European distressed debt strategy next month
Nestled in Hedge Fund Valley in London's Curzon Street, ORN Capital has launched two single strategy funds since its inception in December 1999. Harald Örneberg, founder and chief executive officer of ORN, says the company has plans to launch a European distressed debt strategy, adding to the firm's two existing strategies, on 1 August this year.
'We started with a merger arbitrage fund, but had a clear vision to have more than one strategy and simultaneously build a broad base of talented professionals, each with the opportunity to have a long and rewarding career here,' explains Örneberg.
ORN's second strategy, which was launched in February 2002, is a long/short European value-focused portfolio, run by Fredrik Ervanius.
Ervanius joined ORN Capital following a stint at UBS Warburg as the director of corporate finance in the transport sector and having previously been a portfolio manager focusing on European value stocks at Merrill Lynch Investment Managers.
The 800-stock universe of the European Value Event fund includes companies listed in the European Union, Switzerland and Norway.
The fund focuses on mid-cap stocks valued at between E500m and E4bn, but excludes the telecom, media and technology sectors due to its value sector bias.
'We are looking for catalysts that could send stocks up or down. These events may include liquidations, takeovers and rights issues,' says Ervanius.
'The difference between us and an M&A arbitrage fund is that we invest on the expectation of an event, rather than after the announcement of such an event.' The fund aims to achieve annual net returns of 15%, with volatility of 6% to 7%.
The European Value Event Fund currently has E13.5m under management from a total of three institutional investors, with an additional $20m committed. Both Ervanius and Örneberg are personally invested in the fund.
In-house analysis has indicated that E500m is likely to be the fund's capacity level.
The fund, which will have a maximum of 150% gross exposure, aims to have between 30 and 35 stocks.
'There is a maximum at 30% net long or short, so the fund is reasonably close to market neutral,' explains Ervanius, 'with no more than a maximum of 30% gross exposure to any one sector, and a maximum 10% net, with the same limits applying to country weightings.'
He adds: 'The fund has a maximum holding size for individual stocks of 6% at cost on the long side, and 5% on the short side, although we can let a long grow to 10%. Stop-loss occurs at 1.5% damage to NAV, triggering the sale of half our position, followed by a stop-loss at 2.5% damage, at which point we sell the remaining position.'
The portfolio has a two-month notice period and monthly liquidity without exit penalties.
While Ervanius says stock-picking is his forte, some of the ideas might be generated through macro factors such as regulatory anomalies that affect whole markets ' an example being the Netherlands' takeover laws, which presently favour target companies.
'If you are a manager of a Dutch company, it is practically impossible to be taken over against your will. Even if you own 100% of the shares in the company, you can't appoint the board of directors, for example, and a CEO of a company can issue up to 50% non-voting preference shares to friendly foundations to protect himself.'
takeover targets
Ervanius says he is long a number of Dutch takeover targets with high free-float ratios, as he believes the Dutch authorities will try to amend their takeover code before a European-wide takeover code is imposed upon them.
'Our investment process starts with broad-based ideas, for example, Dutch companies with high free-float, ripe for takeover. After the initial screen, we earmark those companies we feel are adequate for in-depth analysis of fundamentals. As a final step, we visit the ones we really want to concentrate on.'
Ervanius has visited all the firms in the portfolio. He has also been examining corporate balance sheets and cashflow to find weak firms that may enter liquidation, or conduct rights issues, before the broader market has even considered they may conduct rights issues.
'I would not call myself an aggressive investor, but I am definitely trying to make money on the short side ' in fact, I have already made money there,' he says.
The fund exploited some poorer than expected first quarter announcements from firms, including Swedish stockbroker Carnegie and Germany's SGL Carbon, which sent stock in the companies down by between 15% and 20%.
The latest addition to ORN's European Merger Fund and European Value Event Fund is a European Distressed Debt fund, set for launch on 1 August. The distressed debt fund is aiming to return between 15% and 20% a year and will have total capacity for E400m. It will have both Euro and dollar share classes.
ORN's first fund ' the European Merger Fund ' is managed by Örneberg. He explains that the portfolio buys stocks involved in announced M&A transactions, with one leg in either Europe or certain Commonwealth countries. The bulk of the M&A deals in which the fund has participated have been European cross-border or European domestic deals. The fund, which as of June 2002 has $205m under management, recently soft closed to new investors and is set for a hard close at $300m. Örneberg disputes the claim that returns from the fund may suffer due to merger and acquisition activity drying up. 'We are focusing on the mid-caps, with half the fund's book in companies with a market cap of less than $1bn. That's important, because if you compare 2002 with 2001, M&A deal volume fell ' but it fell a lot less in the mid-cap space. In Europe, second quarter M&A activity was up about 15% on the first quarter.
'There were still deals there,' he explains, 'because, in general, mid-cap transactions were more driven by strategic logic, often natural consolidations for strategic reasons within an industry. Larger transactions are often driven by financial considerations and hence the volume of large deals fluctuates with market sentiment. While larger transactions can be more transformational ' AOL and Time Warner, for example ' but we are not seeing any of those at the moment. Our primary research is also better rewarded in the mid-caps. Because our fund is reasonably small, we can play the mid-cap region and still get full profit attribution from a deal going through.'
strategic moves
Örneberg seeks to profit from the 'murkiness' created by different jurisdictions having different M&A legislation.
'Having different laws creates opacity but the ability to see through this is what we get paid for. If you had one law across Europe, returns would be similar to those in the US.
'In Europe, with every country having a different law, returns are higher. If fewer investors feel comfortable in a country due to M&A laws it can create better returns for those investors who have put in the work and understood the rules.'
ORN Capital's unleveraged merger fund limits damage from any single deal to 2% of NAV and typically holds about 35 positions. It will generally be fully invested.
With 3% annual volatility, the fund has had only two negative months since inception, and returned investors 13.4% in its first year, 7.92% last year, and 2.2% this year to the end of May.
This 2.2% return from the fund this year still sits well compared with average announced merger fund returns of between 0% and 3%.
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