Hedge Funds Review European Single Manager Awards 2016
Equity long/short funds are the most common hedge fund strategy, so being able to stand out in this crowded area is an achievement. Concentrating on a niche market is one way.
Elementa, launched in early March 2015 by fund manager Marcus Wahlberg, has a Nordic focus. The fund looks at small and mid-cap companies active in the Nordic countries using deep fundamental research to pick companies that he believes have tangible profits and cashflow upside.
The strategy is clearly working for the Swede. In 2015, the fund delivered an impressive 17%. This is even more astonishing given this was the first year of the fund's life when managers are most likely to be distracted by the mechanics of setting up a business. Markets were also not helpful, as the year was turbulent from the start.
Wahlberg started the fund with the help of PSG Capital, a micro-cap long-only fund manager that incubated Elementa on its platform. This gave Wahlberg the opportunity to create his own management company while establishing a track record for the fund. He moved the fund this summer to his own company, Elementa Management, where he has a majority stake and approval from the Swedish financial supervisory authority. PSG Capital retains around 10% interest in the management company.
Wahlberg sees his edge in the fact that he concentrates on fundamental research to find companies no one else has looked at. Sticking to small and mid-sized companies means there is little or no research available and less likely to be attractive to institutional investors.
“I have to deliver returns and if I want to do that I have to go and find great, small companies with a lot of potential for growth and market improvement.”
He aims to give investors double-digit returns with a high hurdle rate but low volatility.
This is very much a hands-on strategy. Elementa actively looks for companies that offer sizeable markets and business model scalability without sacrificing profits or cashflow. By identifying these companies early in their growth cycle and through disciplined investment parameters, he has managed to obtain attractive entry points into some interesting companies. He believes the Nordics are particularly welcoming to niche companies.
The long side of the portfolio has investments in a wide range of companies with a diverse range of activities including mobile messaging, a global manufacturer of advance equipment for safety, fire and automation applications, a leading "casual dining" restaurant specialising in pizza, a company providing investment and portfolio management software services to leading investment managers, and a supplier of tailored business simulation and other interactive education tools.
"We adjust the sizing of position and net exposure according to the market environment. At present it is on average very expensive out there. I would say that net exposure is low so my sizing is a little bit lower than average on the long term," he explains.
Long positions usually stay in the portfolio for three to five years. Even with short positions, the thinking is long-term. “We’re more like private equity when we go long or short. We don’t have the same process as private equity but we think more like them when choosing to buy or sell a company,” Wahlberg explains. “If the price increases a lot and valuation becomes too high, then we may sell within a year, but if it is someone we like, we may keep it for more than five years. It depends on valuations,” he continues. “We think long-term but when it comes to shorts, it costs money to borrow shares so we want to see a trigger faster than for our longs. For longs we choose the best companies with the best long-term potential and stay with them, increasing or decreasing positions, but we stay if the valuation does not become too aggressive. For shorts, we want to see a trigger earlier.”
Before setting up the fund, Wahlberg was an investment director at Investment AB Öresund, a publicly listed investment company managing assets of more than Skr4.5 billion ($540 million). He was also CEO of its subsidiary Ven Capital (2012-14) and gained direct hedge fund experience from H Lundén Asset Management (2008-11), the management company of the hedge fund Eikos, a Skr4 billion long/short equity hedge and subsequently converted to a family office. His background includes work in mergers and acquisitions from Carnegie Investment Banking (2005-08), a Nordic investment bank, and Credit Suisse in London.
The main driver for an investment is a company’s fundamentals and pricing relative to its current earnings and growth potential, not size and liquidity. For the long book, he wants “robust, niche companies” with positive cashflow generation and controllable downside features. Shorts are typically in structurally challenged sectors and those that are excessively valued with a tangible catalyst.
By concentrating on the less analysed small and mid-cap market, Wahlberg is able to develop his own ideas rather than chasing after the more crowded trades. Exploiting his network of contacts in a variety of industries across Nordic markets, he is able to identify, research and develop investment opportunities.
His “network” comes mainly from his time working in investment banking and the private equity contacts he made. The chairman of Elementa, Matts Ekman, is the present chairman of Carnegie Funds. He was chief financial officer in two of the largest companies in Sweden. The founding investors also have good networks that they share with Wahlberg.
Company fundamentals and then valuation is his starting point when looking at companies. “We want to see low valuation compared to the potential in three to five years, even if the valuation is not necessarily low today. We try to find the cheapest companies that are great.”
He defines a "good company" as one where there is a competitive business model, where the company has some kind of "edge" that will deliver in the coming years.
Such companies may be global but small and managing to get large companies as customers. "We think that is a good way to start: what kind of customers they have means a lot."
Wahlberg also looks at the history of the company and spends a lot of time with management to understand how it operates. "We can't just look at historic numbers. We need to question management. We don't want small companies that will fail. We want to see companies that already have a good, strong position and something to bring to the table in terms of scalability. We don't invest in companies where the competition is too severe."
At present, Wahlberg's universe includes around 500 companies in the Nordic region that are investable for the fund. "We have to generate our own ideas. We have to find companies that look interesting and then look more into them."
He says he reads of lot of newspapers and magazines in addition to using his network in order to generate ideas.
He begins looking at longs once he has his “gross list” and starts to dig into the company’s annual and quarterly reports. He talks to the management of the company as well as to its competitors, its customers and employees at companies that use its services or products. “That’s the company analysis part. We don’t want to hear just the management story. Before a meeting or teleconference, we think about why we want to own or short the company and then test our idea on management and sometimes on the customers and competitors. If it is as interesting as we thought, we build a position.”
Wahlberg characterises his method as a "robust commonsense business model". If he sees a clear route to value creation, with scalability of concept and growth by underlying market or through company-specific factors or even acquisitions with a credible and actionable game plan, he is interested. He wants to see a competent and motivated management team, preferably holding shares in the company.
Small and mid-cap companies will typically have a maximum market capitalisation of Skr20 billion at the time of investment. Short-term holdings are usually held for a year, or longer if interesting. These are usually the "forgotten" mid and small-cap companies with sound businesses that can be bought at attractive valuations.
The companies that Wahlberg shorts usually have structural problems that are not correctly reflected in the price, challenging valuations based on perceived flawed assumptions, and/or aggressive accounting principles related, for example, to revenue recognition, expense capitalisation and recurring exceptional items. These companies usually have unrealistic assumptions regarding synergies related to acquisitions, growth potential or expectations on improved profitability. He also tries to find highly volatile companies with lumpy project businesses.
Elementa also invests in the Nordic high-yield bond market. Mid-market issuers have recently become more common and there are opportunities for informed investment in this area, believes Wahlberg. The fund has the ability to invest in the entire capital structure, including bonds. The decision is taken with a keen eye on risk/reward relative to equities. Essentially he is looking for situations with equity-like return dynamics, with an internal rate of return opportunity of over 10%.
Typically exposure can range anywhere between 0% and 25%. Positions are taken only where there is a "wide margin of safety and strong upside tilt".
The fund looks for diversification across different industries and geographies to control single factor risk. For example, the portfolio in December 2015 held positions in consumer discretionary and IT/technology companies, business services, distribution, financials, fast-moving consumer goods, industrials, healthcare, consumer and basic materials, as well as consumer discretionary. Many of these positions were below 10%. The short side had a similar spread of sectors but also included investment vehicles, automotive retail, media and construction.
Typically the portfolio will have between 15–25 long positions and 20–30 short ones. Indexes and futures may be used for downside protection and are not part of the core strategy. The portfolio is balanced to avoid systematic bias towards industry and geography.
A maximum of 25% of net asset value can be deployed outside the Nordics, otherwise all investments are in the region.
Once assets under management rise from the current $30 million to around $150 million, Wahlberg says he has two choices: either start another fund with the same fundamental research style, but focusing on large-cap companies from the region or more likely, expand the current fund by adding more countries in Europe. The idea whatever happens is to retain the investment style and continue to deliver high absolute returns for investors. “We will stay small,” he says, adding: “We’re not asset gatherers. It is all about performance. You have to deliver that for your investors.”
Wahlberg has already had discussions with institutional investors in the US and Sweden. He believes the fund is most likely to be attractive to funds of funds and institutional investors that focus on absolute return funds, especially those with a history of investing in stock-picking equity long/short funds. "For those kind of investors, the high absolute returns this fund has the potential to offer would be perfect," he says.
Elementa (Elementa Management) also won best niche strategy emerging manager at the Hedge Funds Review European Single Manager Awards 2016.
The week on Risk.net, September 8-14, 2018Receive this by email