Interview: Anders Lekholm, Zmart Alfa
Stockholm (HedgeNordic) – During the summer, the Nordic Hedge Index (NHX) family was joined by Zmart Alfa, an equity-focused absolute return fund managed by Swedish asset manager Zmartic Fonder AB. Like all funds that purport to have an absolute return mandate, Zmart Alfa strives to generate positive returns regardless of market conditions.
Zmart Alfa was launched under the umbrella of Zmartic in March 2015 by Anders Lekholm (pictured) and Magnus Angenfelt. Magnus, who has an extensive experience from Brummer-backed Manticore, has been the head portfolio manager for the fund until recently. Earlier this year, Magnus decided to leave Zmart Alfa to start a new business and Anders Lekholm took over the responsibility of managing the fund. Aside from serving as the head portfolio manager of Zmart Alfa today, Anders also manages three actively-managed mutual funds at Zmartic Fonder. In an interview with HedgeNordic, Anders described Zmart Alfa’s investment process, philosophy, among other things.
HedgeNordic: Can you give us a short history of the fund and your main investment principles?
Anders Lekholm: Zmart Alfa is a market-neutral long/short equity fund with focus on investing in the Nordic region. When we in 2014 decided to launch an absolute return strategy, we saw an increased demand for regulated fund products. The idea behind Zmart Alfa was to offer an absolute return product in a UCITS format to investors as a complement to traditional fixed income exposure that also had low correlation to traditional asset classes. This fall we will implement a slightly modified investment model. The investment process is going to be more systematic in nature, but it is still based on fundamental analysis and consists of two basic investment principles; “value” and “quality”. The overall value creation takes place by investing in companies with a strong or improving operational momentum (profitability, leverage and operating efficiency) that also are attractively valued, and short companies with a negative operational momentum and which at the same time we believe are overvalued. The investment objective of the fund is to generate an annual net return of 4 – 8 percent.
HedgeNordic: Can you elaborate on the investment strategy and stock selection process? What sort of fundamental or technical analysis do you perform on the underlying securities prior to making an investment?
Anders Lekholm: The market-neutral strategy is based on fundamental arbitrage and we will use a systematic process to analyze the companies in our defined universe. The investment process consists of an initial phase where we identify the investment universe and simultaneously decide on different restrictions and limits (for example: a minimum market-cap limit). Then we conduct a financial statement analysis with statistical models to avoid firms at risk for financial distress or financial manipulation. In the stock selection process, we sort companies based on a relative valuation perspective but also with regard to quality – by analyzing the company´s current financial position and operational momentum, including fundamental factors like; earnings, improved cash flow and gross margins, leverage etc. The fund is created by investing in a diversified portfolio of stocks, taking long positions in the cheapest, highest quality stocks and simultaneously shorting the most expensive stocks with low quality and weak operational momentum. In the stock selection process we also take into account qualitative characteristics (such as brand value, management, competitive advantages etc). We strive to keep the portfolio beta-neutral. The portfolio generally holds between 120 and 140 positions in total and the fund´s gross exposure will normally amount to approximately 175-190 percent.
HedgeNordic: Stock-picking skills are paramount to a fund that seeks absolute returns, can you share some details about yourself and your experience?
Anders Lekholm: I have 20 years of experience in the finance and asset management industry. Even though my main focus has been in the equity markets, I have experience from different asset classes such as the fixed income markets. During the years of 2001 to 2012, I worked at the Second National Pension Fund (AP2) as Head of Equity trading and as Portfolio Manager for an absolute return mandate. At AP2 I gained broad experience from various absolute return strategies, both from the internal management team as well as through external mandates. I also have experience from working at Bear Stearns and Merrill Lynch in the United States, as an analyst focusing on single stock analysis.
The investment process in Zmart Alfa is built on a model where we select undervalued and overvalued stocks based on fundamentals. I have done a lot of research and tested which value factors work well or not within a long/short equity strategy. What I found out was that one of the best performing factors for capturing the value premium is to use the EBITDA/EV multiple. I also believe that market prices can never be perfectly efficient. If prices always were efficient, skilled investors with better data collection and processes would never be rewarded. At the same time, I don´t believe in using just one fundamental metric for the stock selection process or to pick only one “Apple”. Can you tell if Apple will fall above or below their next earnings forecast and how the market reaction will be? No one knows for sure. The model we employ for Zmart Alfa, uses many different value multiples and quality factors combined and the portfolio construction will create a “bucket of Apples”. Some positions will not deliver, but on average the long portfolio will outperform the short positions over time.
HedgeNordic: Of all the alternative investment strategies currently available to investors, what are the main reasons to consider a long-short investing approach similar to yours?
Anders Lekholm: In this low interest rate environment, some investors have turned to alternative investments to manage risk and potentially improve returns. Many alternative investment strategies deliver parts of their returns from having some kind of market exposure. In times of higher volatility or at crises, these strategies are going to struggle to deliver returns. With a market-neutral strategy, like Zmart Alfa, the investor is positioned to receive an absolute return regardless of the market situation.
HedgeNordic: In what market environments does your long-short strategy work best and conversely, in what environments do you anticipate to struggle relative to other alternative investment strategies?
Anders Lekholm: Typically, market-neutral equity strategies are going to underperform the general equity market during bull markets, and outperform in environments that tend to be more difficult for long-only and other hedge fund strategies. Since market-neutral strategies strive to take advantage of an inefficient market and by variations among stock returns, the strategy works well when stock returns cluster together with high correlation. Similar long/short strategies (to Zmart Alfa), with a longer track record, have shown very good results over different market cycles and they also have a very high ratio of positive months. But since the portfolio has to take risk to generate alpha, the fund will also have periods with no return or negative returns. Zmart Alfa´s strategy could be sensitive to style (value vs growth), since part of the investment strategy is to identify and invest in companies with attractive valuation. The fund could therefore struggle in periods when the spread of growth increases dramatically vs value or in times when mid,- and small-caps are less favourable. We try to minimize this risk in the stock selection process by excluding “speculative growth stocks” and companies with a historic data less than five years. We also balance the long/short portfolios by style, capital size and sector exposure.
HedgeNordic: Zmart Alfa is the only hedge fund-like fund managed by Zmartic Fonder, how does this fund differ from the other funds you manage? What competitive edge do you provide the investors of this fund with?
Anders Lekholm: The other long-only funds we manage, focus on delivering high risk-adjusted relative performance, while Zmart Alfa focus on absolute performance. Having the ability to go both long and short doubles the investment universe compared to a long-only fund. An absolute return fund can be particularly helpful to investors in down markets or in times of increased volatility, capturing alpha with low volatility while at the same time hedging out market risk. Our view is that Zmart Alfa should be seen as an important diversifier within a balanced portfolio.
HedgeNordic: Is there a particular niche of investors that you are aiming to attract for investments into your fund?
Anders Lekholm: Since absolute return strategies aim to deliver positive returns even when financial markets are declining, we aim to offer Zmart Alfa to investors who are looking for stable risk-adjusted returns and with an investment horizon of minimum three years. As I already mention, we also think this product fits well to investors as a complement to traditional fixed income exposure. The fund offers clients the opportunity to participate in the equities market, but with much lower risk and without being dominated by a benchmark or the direction of the market.
HedgeNordic: With so many funds out there, how does Zmart Alfa differentiate itself from other funds that fall into the “absolute return” category?
Anders Lekholm: First of all, we attempt to produce consistent performance. Over time this is the key differentiator. Secondly, Zmart Alfa is suitable for both retail investors as well as institutional investors, but retail investors wants products that are easy to understand. We think that our long/short strategy is pretty basic and not so “technical”. Since Zmart Alfa´s legal structure is UCITS-compatible, we also see an advantage of being able to offer daily liquidity and keeping the process transparent. The universe of market-neutral hedge funds focusing on the Nordic´s is also very limited. And as for almost any other industry, asset management companies need to work persistently with product innovation to remain relevant over time and trough different market regimes.