On the positive side companies have reported very solid quarterly reports for the first quarter. This is especially true for cyclical companies, where the positive order momentum continues.
e-fundresearch: Which are the most important elements in your investment process?
Nilsson: The investment process is built upon six steps:
The most important elements in the process would be identified as being Fundamental research, Valuation and Selection. Please see below for more details:
In this part of the process, fundamental research is used to validate or disqualify an investment candidate. A large emphasis is put on understanding the value chain and the company’s current and potential position within the industry.
The team meets with a large number of companies each year, both in conferences and site visits (approximately 200 company meetings per year and fund manager). The aim with these meetings is to verify that the management teams are committed to: create shareholder value, have interests that are aligned with investors and further improve the company’s position within the industry.
Companies with a management team with a strong track record are preferred.
For all positions in the fund, the fund managers have a strong opinion on the valuation. This is derived from a proprietary in-house valuation model (abnormal earnings model) and is verified through other valuation approaches that differ depending on the characteristics of the investment candidate. In some cases, a sum-of-the-parts approach might be interesting, whereas in others, relative valuation might prove more useful.
The fundamental view on a certain stock determines the size of the position. If the fundamental value is much higher than the current value implied by the market and the down-side is viewed to be fairly limited, the position taken is often sizeable. The team tries to identify stocks with a strong risk-reward, but prefers to invest when the valuation can be complemented by a positive earnings trend.
The position is reduced when the risk-reward turns more negative, i.e. when the stock reaches closer to the fundamental value.
The investment process is mainly bottom-up driven. In the selection process, however, a large emphasis is put on portfolio characteristics. Even though a potential investment might look good as a stand-alone investment, it does not necessarily pass the selection process. This is because the fund managers focus on avoiding too many cross-correlated bets, which might otherwise have affected the risk/reward of the portfolio negatively.
Stocks are selected from a risk/reward perspective. This means that a potential investment might be disqualified even though the fundamental value looks great if there are question marks around how large the potential downside is and/or if the managers are uncomfortable with certain risks.
e-fundresearch: Which over- and underweights do you currently hold?
Nilsson: The over- and underweights are only a residual effect (unintended bet) of the stock selection process. The fund follows a pure bottom-up approach when building the portfolio. However, please find below the fund´s sector and country O/Uweight vs the MSCI Nordic Index as of 30.04.2012.
At sector level, fund had an important overweight in more cyclical sectors (Industrials, Consumer Discretionary). Conversely the fund´s largest underweight appear in Telco.
At country level, the fund´s largest O/W is Norway and U/W is Sweden.
e-fundresearch: Please comment on the performance and risk parameters of your fund in the current year as well as over the past 3 and 5 years.
Nilsson: Comment 2008
2008 was a unique year in terms of both depth and width of the recession, which affected most global markets and sectors. The Nordic Stock markets were impacted by this, since there is a high concentration of export-oriented companies. Therefore, the fund´s performance was negatively impacted, in absolute terms, due to weak performance in especially the Industry-, IT- and energy sectors.
We have focused on companies with strong balance sheets and relatively stable cash flows. As the crisis deepened, we reduced exposure to the banking sector. Our holding in the pharmaceutical company Novo Nordisk and the insurance company Topdanmark contributed positively to the performance of the fund. Our holding in the Norwegian holding company Aker showed a weak performance and the company’s holding in Aker Solutions had a tough year.
After a muted start, Nordic stock markets recovered strongly during the remainder of the year. Extensive global stimuli measures have helped to cushion the economic downturn. Our fund performed strongly during the period and exceeded the benchmark return with close to 9%.
We entered the year with a reasonably cautious view with limited exposure to cyclical and weakly capitalized companies. We utilized the weakness in the early part to add to some cyclical exposure, which proved to be a successful strategy. The holdings in FLSmidth, Konecranes and Outotec developed well. A common denominator for all these is a favourable business model and strong balance sheets. Among the banks, DnB NOR has weathered the crisis much better than the market initially feared, which benefited the relative return of the fund. In addition, the media company Schibsted has recovered strongly post announcing a large cost-cutting program.
After a cautious start to the year, the Nordic stock markets developed strong in the second half. The industrial sector led the positive trend, driven by strong global GDP growth and significant profit improvements. In Europe, the differences between countries´ development has been evident. Germany, which has great importance for the Nordic exporters, has shown strength, while countries such as Greece and Ireland had to rely on financial support to manage their weak public finances.
The fund showed good absolute returns over the year, but did not exceed the benchmark. This was mainly because we had a quite high proportion of cyclical companies in the spring, when the stock market was weak. The fund showed, however, a strong recovery in the second half of the year.
Investments in well-managed companies with strong balance sheets, such as Novo Nordisk, Konecranes, SKF and Yara contributed to the returns of the fund.
During last year the Nordic stock market was negatively impacted by the stress in the European financial markets, which was triggered by worries about the sovereign debt levels in Southern Europe and failure by politicians to tackle the problems in the Eurozone. The sell-off in the Nordic market was, in our opinion, triggered by top-down decisions based on an assessment of the macroeconomic environment and global political risks. The sell-off affected both the funds absolute and relatively performance in a negative way. We viewed Nordic equities as attractive following the turbulence in the market and utilized the market weakness in August and September to enter into companies where we weren´t invested previously. At the time, we argued that share prices were more penalized than what could be fundamentally justified despite a weakened macroeconomic outlook. The companies we bought in to were especially Nokian Tyres and Wärtsilä and they are two of best contributors to the great performance during the start of 2012. Going forward, we are cautiously optimistic for the outlook of Nordic equities. Market expectations for future earnings have been slashed and estimates now seem achievable. In addition, Nordic companies on average have very strong balance sheets and well established global market positions and, thus, have a sound platform for continued long-term value creation.
e-fundresearch: What is your outlook for the Nordic region compared to overall Europe?
Nilsson: We believe that there are several reasons to remain positive on Nordic equities for the medium term. The valuation continues to be attractive and the Nordic companies’ strong balance sheets and well-established global market positions provide a sound platform for continued long-term value creation. There are, however, a couple of dark clouds on the sky on the macro front, which potentially could become more in focus once we exit the reporting season. Thus, a balanced approach is justified going forward. However compared to "European companies" Nordic companies should have an advantage based on strong domestic economies and a good exposure to the U.S. and emerging markets. The fund consists of, what we view as quality companies, with a relatively low or no exposure to Southern Europe and strong global market positions.
When referring to the Nordic economies, they should fare better compared to Europe, as they are economically strong with either budget surpluses (Norway and Sweden) or low budget deficits (Denmark and Finland) and amongst the lowest debt as a percentage of GDP in the world.
e-fundresearch: Thank you for the interview!