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The Siloing Effect of Equity and Credit Markets

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Stockholm (HedgeNordic) – Tidan is different. River Tidan is one of the few rivers in Sweden that flows from south to north. Michael Falken, the CIO of hedge fund start-up Tidan, says their strategy aligns with its namesake. “We view our strategy as fairly unique with the potential to offer investors a differentiated source of alpha.”

Michael Falken and William Wilson, joined by fellow Brummer alumni Gunnar Wiljander, have launched a new hedge fund that employs a capital structure relative value strategy. “We benefit from eight years of research and development at Brummer, with myself and Will at Goldman Sachs having over 40 years of combined experience employing capital structure relative value strategies,” Falken tells HedgeNordic. “Capital structure relative value is a neglected space. The siloing effect of equity and credit markets means this space falls between the cracks. There are not a lot of managers operating in this area.”

“Capital structure relative value is a neglected space. The siloing effect of equity and credit markets means this space falls between the cracks.”

“Brummer was a particularly supportive and innovative platform, which we are very happy to have been part of,” says Falken. “With the toolset that we developed at Brummer, we felt that it was a great springboard to set up on our own.” The ex-Brummer trio launched Tidan under the umbrella of Tidan Capital in mid-October with the support of cross-asset trader Aram Hussein, formerly at Brummer & Partners. Gunnar Wiljander, the former CEO of Nektar – one of Sweden’s oldest and largest hedge funds, is overseeing Tidan Capital as CEO, with Michael Falken and William Wilson having full responsibility for the management of the fund that currently oversees €93.5 million in assets under management.

The Basics of Capital Structure Relative Value – Value Transfer Alpha

The concept of informational effiency suggests that financial markets – equity, fixed income and derivative – should be closely correlated with each other. Occassionally, however, there is some level of lead-lag relationships among stock and bond markets. “Beneath the surface of broad market indices, there are thousands of companies living their own lives, having their own dislocations in their own capital structure,” explains Falken. “There are thousands of companies with individual interconnections between their debt and equity securities, where much larger dislocations can emerge.”

“Beneath the surface of broad market indices, there are thousands of companies living their own lives, having their own dislocations in their own capital structure.”

Tidan’s strategy utilizes mispricings and dislocations within a single company’s capital structure. The fund focuses on going long undervalued securities linked to one part of the capital structure and simultaneously going short overvalued securities linked to another part of the capital structure. “Because the space is neglected, employing fundamental research with a focus on understanding a company’s capital structure and capital allocation policy allows us to take advantage of these attractive dislocation opportunities.”

“Our strategy focuses on the relationship between equity and credit,” elaborates Wilson. “When going long credit and short equity, we look for companies that will transfer value from shareholders to bondholders,” he explains one of the two types of relative value trades carried out by Tidan. “The simplest example is an over-levered company where the management team realizes the balance sheet is not appropriate and therefore plans to de-lever.”

“Our strategy focuses on the relationship between equity and credit.”

“The other trade is the exact opposite. We are looking for value transfer from bondholders to shareholders,” continues Wilson. This situation occurs when a company’s management team believes re-levering is appropriate as the business performs well and grows or when third parties such as activists or private equity are circling around.

Tidan’s trades are all carefully constructed to be market- and company-neutral. “All of our trades are constructed to isolate our value transfer view, where we feel we have a genuine edge,” says Wilson. “We call this Value Transfer alpha,” he adds. “We know we have no edge in predicting a company’s next earnings results or the next big factor move, so we target to hedge out all of that noise. We believe this contributes to our low correlation to other asset classes.”

Enhanced Toolset

Tidan is employing an evolution of the capital structure relative value strategy run within Brummer & Partners-backed Carve. “We believe the original capital structure relative value strategy from Carve is attractive because there are not a lot of people doing it,” argues William Wilson, who left Goldman Sachs in 2018 to join Carve Capital. “But in no way are we relaxing. We are finding more ways to refine the strategy, enhance our toolkit and discover different types of opportunities that exist.”

“We believe the original capital structure relative value strategy from Carve is attractive because there are not a lot of people doing it. We are finding more ways to refine the strategy.”

“Tidan’s strategy is similar to the one used at Carve in the sense that we participate in the capital structure, we have more than one position in every single company, one being a bullish and one being a bearish position,” explains Falken. “Beyond that, everything is different. The way we approach portfolio construction is much different from what we did at Carve. We continued to develop the toolset, which is now much more enhanced. On top of that, we have an overlay hedge that we did not have at Carve.”

Market Environment and ESG Value Transfer Alpha

The recently-launched Tidan seeks to invest in around 40 investment opportunities at any given time, with both micro and macro factors constantly creating opportunities. “There are a lot of idiosyncratic events creating dislocation opportunities and we are looking for events driving value transfer across capital structures,” Michael Falken tells HedgeNordic. “It is key to have the experience to understand the dislocations that are going on in the market at any particular time,” adds Wilson. “These dislocations partly occur because market participants generally trade equity and credit in isolation from each other,” he explains. “This happens across all markets.”

“There are a lot of idiosyncratic events creating dislocation opportunities and we are looking for events driving value transfer across capital structures.”

“The Environmental, Social and Governance (ESG) trend is also creating dislocations across the capital structure,” elaborates Wilson. “Our strategy resides within the world of capital allocation. The ESG theme is manifesting itself in the market through how and if capital is allocated to certain sectors and companies, causing capital structure dislocations,” he continues. “A greater number of capital structure dislocations are being born out of ESG events and that fits our core competence,” Wilson tells HedgeNordic. “If we see a company that has been deficient on the governance or environmental side, and we think that the board has the desire to fix that, that is an opportunity for us. The deficiency may be remediated and the dislocation then closes.”

“The Environmental, Social and Governance (ESG) trend is also creating dislocations across the capital structure.”

At full speed, Tidan will maintain a portfolio of around 40 investment packages, with every package having at least two opposing positions in different credit instruments, equity, options or a combination of those. Investments are typically held for 6-24 months and the portfolio is expected to achieve a market-neutral target return of 7-10 percent net of fees for its investor base of professional investors.

 

This article features in HedgeNordic’s 2021 “Alternative Fixed Income” publication.

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Eugeniu Guzun
Eugeniu Guzun
Eugeniu Guzun serves as a data analyst responsible for maintaining and gatekeeping the Nordic Hedge Index, and as a journalist covering the Nordic hedge fund industry for HedgeNordic. Eugeniu completed his Master’s degree at the Stockholm School of Economics in 2018. Write to Eugeniu Guzun at eugene@hedgenordic.com

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