Stockholm (NordSIP) – In May of 2016, Swedish hedge fund shop Atlant Fonder launched a new hedge fund investing only in equities and corporate bonds with a sustainable profile. Through shorting the Eurostoxx50 and using short delta option strategies against these holdings, the fund aims to be market neutral. In essence, this translates into a fund that goes long of sustainable companies and goes short the market, including companies being less highly ranked in terms of their sustainability work. Can this be an innovative way to extract alpha? HedgeNordic sat down with portfolio manager Anders Blomqvist (pictured) to have him sharing some thoughts about the new fund named Atlant Responsible.
What is the reason behind launching a sustainable hedge fund?
The reason for launching a hedge fund that has a sustainability focus is twofold. On the one hand it is a result of our view that sustainable companies in the long run holds an advantage to those that ignore these issues, which also should translate in them being more profitable and in the end higher valued than non-sustainable companies. Being a hedge fund, we can play both the short and the long side of this trade, which allow us to potentially extract this valuation difference over time. On the other hand, we see a great and increased demand for fund products that embrace sustainability. By having a truly sustainable product we look to tap into this demand. Sustainable products has so far been a rare species in the hedge fund space but we cannot ignore the fact that this has become an increasingly important consideration for investors in the space.
How is the portfolio structured?
The idea behind Atlant Responsible is to be able to offer a market neutral hedge fund that invests in companies with a high sustainability rank. The long book includes companies that are selected from a European sustainability index that excludes everything that can be considered non-sustainable. This is not limited to how the companies approach environmental issues, it can also be applied to how they treat their employees and how ethical standards are structured and applied. The index includes roundabout 190 companies, so there is a large enough universe to chose from.
In order to hedge out the market risk, we use futures and options on the Eurostoxx50 index that includes some of the largest companies in Europe, not taking into account the sustainability aspect. There is an overlap in terms of companies included these indices, so essentially what the net exposure results in is a long position in sustainable companies which is hedged with an index that comprises non-sustainable or less sustainable companies. It is then the net market exposure that we can play given our view on the market.
You are using derivatives to express your overall market view, explain briefly how this is done.
Atlant is known for being able to efficiently express its market views through the use of futures and options. In the Responsible fund we are using options mainly to extract time value and to have a protection should the market go against us in the resulting net exposure from the long Eurostoxx Sustainability and the short Eurostoxx50 trade, which is typically marginally long.
The way we use options is that we sell volatility and collect premiums as long as volatility stays low and there are no extreme expected moves to the upside. We continuously invest part of the proceeds into put options with the purpose to be “over-hedged” on the downside if the market unexpectedly would turn extremely bearish.
This strategy fares particularly well in times of low volatility and moderately rising equity markets, which has been the trend for quite some time.
The worst case scenario for this strategy is that volatility rises quickly and that this is combined with significantly rising equity markets. To some extent this move would be hedged by our long equity positions but losses from sold options would affect performance negatively. This type of market action is highly unusual as the typical pattern is that a significant rise in volatility is coupled with falling equity markets.
What has been your experience so far with regards to performance and exposures?
In order to stay true to the market neutral claim, we can only have a limited net exposure in the fund. Since inception of Atlant Responsible our net exposure has been below the 25 percent threshold of the fund´s NAV, which is in line with stated targets. Contrary to some of our other products, we cannot use a significant amount of leverage in Atlant Responsible. Our return target is 5 percent on top of the risk free rate, defined as the 3-month Euribor fixing, and to achieve that return to a risk that is significant lower than that of the stock market as a whole. So far we are in line with our stated return target.
In terms of market development and how our sustainable approach has played out, one reflection is that the fund tends to have relatively weaker performance in a market environment where commodity companies outperform. Since equities within the energy and mining sectors by definition holds a lower sustainability score, we tend to be short of this sector as opposed to the larger universe of European companies.
The market development post the US election worked in favour of cyclical and commodity related stocks, which played negatively into the performance of Responsible, however our positive market view as of late has had the fund recovering and as of February 2017 we are close to all-time-high levels.
What opportunities or threats do you see ahead?
Going forward we are still optimistic about the stock markets and our base case view is that Swedish stocks are poised for at least another 15 percent run this year. At the same time, statistics tell you that an imminent correction is underway in the US equity market. This could be as significant as a 20 percent drawdown, which would of course have a negative impact on European stocks as well. If this was to happen, I believe that the Responsible fund would be particularly well-suited for offering protection given its market neutral profile while being able to quickly adapt to a new market scenario through the use of options.
This article was published in HedgeNordic / NordSIP special report “Sustainable Investment in Alternatives” in February 2017. The entire report can be viewed here: download