Nordic Long Short - Is it really different this time?

The objective of the fund's management is to generate long-term positive returns regardless of market developments. We achieve this by using fundamental analysis to select stocks that we believe deviate from their fundamental fair value. This means that we buy shares that we consider to be cheap, or short sell shares that we believe are overpriced.

Choosing whether or not to invest in a company's shares based on their financial fundamentals and value is called value investment. It is well documented, for example in the joint academic research by Nobel laureate Eugene Fama and Kenneth French that, over time, value investment creates value.

The performance of Nordic Long Short has been disappointing in 2019. The main reason is that many of the companies we judged to be "cheap" have become even cheaper, and many of the ones we judged to be "expensive" have become even more expensive. A small consolation in this context is that this scenario also impacted many other value-oriented managers.

To illustrate how big the difference in valuation is between different companies when you look at important key figures such as P/B (price/book value), P/E (price/earnings) and P/S (price/sales), value stocks (MSCI Value) compared to growth stocks (MSCI Growth) are now trading more cheaply than during the dotcom bubble of 2000.

Making judgments about the future calls for a large dose of humility. I would guess that most portfolio managers, particularly value-oriented ones, have asked themselves: Why are valuation differences so extreme? What is underlying this? What needs to happen in order for the valuation differences to return to what has historically been normal? Or is it, to use the words many call the most dangerous phrase when it comes to the financial markets, different this time?

However, what really IS different are interest rates. These have never been lower. My guess is also that this is the most important reason why we are experiencing huge valuation differences between different companies. Low interest rates may justify higher valuations, but this should affect all assets. One consequence of low interest rates is that companies, governments and households are taking the opportunity to borrow cheaply, and debt is also the highest we have seen from a historical perspective. One consequence of this is that growth should be structurally lower going forward since we have used borrowing to consume and invest today what we would have otherwise done in the future. To this should be added that there have historically been variations in growth (economic cycles), while there has now been more or less positive growth over the past 10-year period. In historical terms, this is a long phase without an economic slowdown.
A simplistic conclusion from this is that it can partly explain both price trends and valuations on the stock market thus far. But for the valuation gap to continue to increase, more of the same is likely needed, which means even lower interest rates. If, like us, you believe in market economics, it is unreasonable to believe that interest rates will fall sharply from today's situation. What should happen is that companies, governments and households take the opportunity to borrow even more. This will bring with it even more problems, but it would be rational and should create an upward pressure on interest rates rather than downward pressure.

The fund's positioning

For most of 2019, we have had a net exposure close to zero. Looking at the sector exposure, we had a long position in finance and commodity-oriented companies of about 10 percent each at the end of August. In our opinion, these sectors have become very cheap, and include companies such as Norsk Hydro, Sampo, SSAB, Stora Enso, Storebrand and Swedbank. The sectors where we have the largest short exposures are industrials and consumer durables. In these sectors we find companies that, although very likely to be sensitive to an economic downturn, have not experienced the price trend that has impacted the more cyclical commodity companies. In the industrial sector, we are short in companies such as Alfa Laval, Assa Aboly, DSV, Epiroc, Kone, Nibe, Tomra and Vestas Wind.

We also have a number of long positions in the industrial sector, including in less cyclical Securitas and Volvo, which we consider cheap at these levels. We are short in both Thule and Veoneer in the consumer durables sector. Veoneer in particular has experienced weak performance, both purely financial and in terms of its shares price, and we believe this will continue and will therefore maintain our short position. During the year, we had a larger proportion of our short positions in non-cyclical companies in retail or telecommunications. In August, we balanced the portfolio to reduce the cyclical risk, which means we reduced our short positions in these companies. Among these companies we find historically expensive shares such as Axfood, Carlsberg, Elisa, ICA, Kesko and Telia.

In summary, we do NOT think it is different this time. We believe that the market economy will continue to be the economic model chosen by the world. Our conviction is that the historical norms that characterise the market will again apply and that relationships between cheap and expensive companies will then shrink. We believe this will happen in the not too distant future, so the portfolio's position remains long in cheap companies and short in expensive ones. The prospect for Catella Nordic Long Short to generate returns is good, particularly considering the extreme valuation differences that we can observe in the market.

Catella Nordic Long Short

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