Diversification is in the DNA

Stockholm (HedgeNordic) – Achieving true diversification along with better risk-adjusted returns requires a strong pursuit of uncorrelation. Yet truly uncorrelated investments are hard to find. The entire investment team at Nordic Cross Asset Management contribute their individual thoughts and expertise in the fulfilment of the team’s objective to offer a truly uncorrelated multi-strategy hedge fund, which makes up the DNA of Nordic Cross Stable Return.

“For us, it is important to be able to create stable returns at a risk with limited correlation to the market,” explains founding partner and portfolio manager Ulf Strömsten (pictured), who is in charge of managing Nordic Cross Stable Return. One of the fund’s three main objectives is keeping the correlation with equity markets below 0.3. “We have a return target, a correlation target and a risk target,” says Strömsten. “We use them to explain to investors what they should expect.”

To emphasize the importance of uncorrelation, Strömsten says that “we are having a phenomenal year with the fund now up over 21 percent. Still, I am very pleased with last year when the performance was a more modest 5.4 percent.” Last year’s return was achieved with a negative correlation to the broader equity market. “This means that we created that return on days when the stock market was down,” points out Strömsten. “From the perspective of investors, we added quite a lot of diversification to their portfolios and we brought their portfolio risk down by having low correlation.”

“By allowing the fund to allocate between different strategies and to be flexible in that allocation, we can adopt a strategy which is adequate to the kind of market that we are experiencing.”

In addition to targeting a correlation below 0.3, Nordic Cross Stable Return also aims to deliver an average annual return of four to five percent over a rolling three-year period and exhibit an annual standard deviation in returns of three percent. To achieve its threefold objective, Nordic Cross Stable Return employs a multi-strategy approach to investing featuring different equity sub-strategies, as well as fixed-income and derivatives mandates. “We are aiming to have flexibility both in terms of allocation and in terms of how we use different asset classes,” says Strömsten. “By allowing the fund to allocate between different strategies and to be flexible in that allocation, we can adopt a strategy which is adequate to the kind of market that we are experiencing.”

Active Multi-Asset, Multi-Strategy Approach

The equity and fixed-income strategy buckets can each represent between 30 percent to 70 percent of Nordic Cross Stable Return’s entire portfolio. The equity bucket is composed of three additional sub-strategies: market-neutral, long/short and event. The equity market-neutral sub-strategy can account for up to 70 percent of the fund’s entire portfolio, while the long/short and event sub-strategies can represent up to 40 percent and 15 percent of the portfolio, respectively. “We could, in fact, do the entire equity strategy as market-neutral, while we only allow long/short to account for 40 percent of the entire fund,” says Strömsten. “The reason for that is that we perceive the long/short strategy to be riskier than the market-neutral strategy.”

“The bulk of the return comes from the equity part of the portfolio, predominantly from the event and long/short mandates.”

“The bulk of the return comes from the equity part of the portfolio, predominantly from the event and long/short mandates,” says Strömsten. “While the contribution that you get from the market-neutral and fixed-income strategies is pretty low, we use these to diversify the portfolio,” he emphasizes. “We need the market-neutral and fixed-income parts to bring the entire risk of the portfolio down and make sure that the correlations are kept low.” Strömsten goes on to say that “you get an additional return even if the main reason for having them in the portfolio is to bring the risk down.”

“While the contribution that you get from the market-neutral and fixed-income strategies is pretty low, we use these to diversify the portfolio.”

In addition to equity investments, Nordic Cross Stable Return also makes used of fixed-income and derivative instruments. “We take a low-risk approach to build the fixed-income part of the portfolio,” points out Strömsten. “We have a lot of AAA-rated covered bonds and have a small share of high-yield exposure that mainly goes to BB+ bonds.” The derivatives mandate, meanwhile, is used to neutralize unwanted risk, either company-specific risk, sector-specific risk or market risk.

“We continuously change the allocations, with input from the entire team. To get the call right, you have to have a dynamic discussion going behind that decision.”

The allocation process across asset classes sub-strategies relies on a top-down macro-based approach. “We continuously change the allocations, with input from the entire team. To get the call right, you have to have a dynamic discussion going behind that decision. We meet on a regular basis to discuss and share our views on the market,” explains Strömsten.

Return Contributions From Equity Sub-Strategies

“We aim for a contribution of one percentage point per year from the market-neutral strategy when it accounts for 20 percent of the total portfolio to get to our return target of five percent,” explains Strömsten. The market-neutral portfolio is usually comprised of between ten and 20 pairs. The long/short portfolio, which generally houses a combined 20 long and short positions and maintains a net market exposure between minus 30 to plus 30 percent, “is expected to double up in terms of contribution given the same allocation to the total portfolio.” The event-driven strategy, meanwhile, runs a more concentrated portfolio of five to six positions. “We also expect the event portfolio to contribute to two percent at a level of ten percent of the portfolio.”

The stock selection process for all three equity sub-strategies relies on a fundamental bottom-up approach. “We go long in the companies that we believe are fundamentally the most attractive ones and go short the ones that are the least attractive,” explains Strömsten. For the event portfolio, “the event can be an IPO itself or a longer-term process such as a megatrend or a structural trend.” Event-driven investments “represent binary, zero-one kind of investments,” according to Strömsten. “What we do in the event-driven part is that we look for companies with a high share of company-specific risk.”

“There are different perspectives that we take when building the market-neutral, long/short and event-driven portfolios. But they tend to work in different kinds of environments.”

According to Strömsten, “there are different perspectives that we take when building the market-neutral, long/short and event-driven portfolios.” But one characteristic that unites them all is that “they tend to work in different kinds of environments.” The entire bucket of equity strategies generally maintains a net equity market exposure between minus and plus ten percent. “It is not the stock market that is going to create performance here, what is going to create performance is the companies that we pick,” emphasizes Strömsten.

“We have a very good year in terms of stock picking, which has resulted in great performance in both the long/short and the event-driven mandates.”

Nordic Cross Stable Return advanced 21.6 percent year-to-date through the end of October, handily outperforming its long-term return target of four to five percent. “We are having a phenomenal year this year, we are happy with a number of investments that have gone well, particularly in the event-driven portfolio,” says Strömsten. “There is a pretty large number of stocks that contributed to returns this year, so we do not depend on one individual investment for the return,” he continues. “We have a very good year in terms of stock picking, which has resulted in great performance in both the long/short and the event-driven mandates.”

 

This article featured in HedgeNordic’s report “True Diversifiers.”

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About Author

Eugeniu Guzun serves as a data analyst responsible for maintaining and gatekeeping the Nordic Hedge Index (NHX), as well as being a novice columnist covering the Nordic hedge fund industry for HedgeNordic. Prior to joining HedgeNordic, Eugeniu had served as a columnist for a U.S. journal covering insider trading activity, activist campaigns and hedge fund moves. Eugeniu completed his Master’s degree at the Stockholm School of Economics in 2018.

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