Stockholm (HedgeNordic) – In its first full year of operations, Adrigo Small & Midcap L/S was one of the five best performing hedge funds in the Nordics. More importantly, the long/short equity vehicle launched by Stockholm-based asset manager Adrigo Asset Management in the November of 2017 achieved this feat in a particularly challenging year for stock pickers.
The vast experience of the portfolio manager steering Adrigo Small & Midcap L/S might have contributed to the fund’s success, but the design of its strategy has played a role as well. In an interview with HedgeNordic, portfolio manager Staffan Östlin (pictured) chops down the fund’s strategy into building blocks and outlines the characteristics differentiating the fund from peers.
Three Buildings Blocks in Long Book
Adrigo Small & Midcap L/S is a stock-picking hedge fund looking for long and short opportunities in the Nordic small- and mid-cap segment. The fund’s long book is comprised of three building blocks: Core Five; High-Potential; and Dynamic. Although each building block includes companies with different characteristics and serves different purposes, all blocks have one trait in common: CHANGE. “In all our positions, both long and short, change is really what we are looking for,” Staffan Östlin tells HedgeNordic. “Various types of changes: changes in management, for instance, changes in investor perceptions, or structural industry changes, among others.”
The first block is generally made up of five main holdings and serves as the fund’s core building component. This block accounts for half of managed assets at any given point in time. “The core five holdings are high-conviction investment ideas in companies with strong balance sheets and strong management teams that are undergoing some form of long-term change,” Östlin says about the first block. These ideas typically have an investment horizon of three to five years and each core idea accounts between eight and 12 percent of net assets. “We use a selective and value-oriented approach to build our portfolio of core holdings,” says the portfolio manager. “These holdings tend to have low operational risk and low balance sheet risk, but all of them face some challenges that require time to get sorted out,” he adds.
The second block comprises long-term, high-return potential ideas, which collectively account for 15 percent of net assets on average. These high-potential holdings usually include microcaps with market capitalizations between SEK 300 million and SEK 1.5 billion. “We expect some of our high-potential ideas to end up as ten-baggers eventually,” reckons Östlin. “What our high-potential ideas have in common is that sell-side research analysts do not cover most of them, they have strong management teams, and have commercially viable products on the market,” the portfolio manager adds.
The third and last block consists of more opportunistic investment ideas, which tend to have an investment horizon between one and nine months. “Our dynamic investments allow us to react when market conditions are changing, which means we can avoid being stuck with one strategy that underperforms in certain market environments,” Östlin explains the benefits of the last block. “The high-potential and opportunistic ideas allow the fund to carry the core value-oriented strategy unbruised through turbulent market conditions,” he adds. According to the portfolio manager, the combination of long-term fundamental investing and the more opportunistic approach to investing represents one of the fund’s main competitive advantages.
The Short Side of the Portfolio
Adrigo Small & Midcap L/S is a long/short vehicle with a long bias, normally maintaining a net market exposure between 20 and 40 percent and gross exposure of up to 170 percent in normal market conditions. According to Östlin, “the net exposure depends on the number of attractive investment ideas we can find on both the long and short side and not on our macroeconomic or general stock market views.” The fund maintains a concentrated portfolio of 15 to 25 long positions, with roughly a similar number of short positions.
Although the fund’s portfolio management team – comprised of Staffan Östlin and portfolio manager Johan Eriksson – seek to pair the long positions with equally-attractive short positions, all short positions are initiated on their own merits. “We use the same methodology and approach to select both long and short positions,” says Östlin. “We know our holdings inside and out,” he adds. The team are doing five or six company visits per week on average, and have conducted more than 200 visits since launching in November of 2017. Östlin and Eriksson rely on internal research to find investment opportunities, but they do communicate to sell-side analysts, the competitors of their investment candidates and current holdings, and other industry representatives.
When searching for short opportunities, meanwhile, Adrigo Small & Midcap L/S prefer to short market darlings near inflection points, companies hurt by structural shifts in their industries, or companies using aggressive accounting. Since Adrigo’s younger vehicle focuses on the small and midcap segments of the stock market, the fund seeks to avoid any liquidity risks on the short side by shorting more liquid companies with higher market capitalizations. “The average market cap is higher on the short side,” says Östlin. “We never short companies with a market cap of less than SEK 500 million for example,” he adds. In addition to conducting fundamental research, the team also use technical analysis when entering and exiting positions. “Sometimes we go against the chart but we never buy a stock or short a stock without looking at the chart,” concludes the lead portfolio manager.