Stockholm (HedgeNordic) – In contrast to benchmark-hugging managers, a truly active equity manager combines independent thinking, strong conviction, and a long-term perspective to generate superior investment results for clients. Ernst Grönblom has spent over a decade exemplifying the art of true active equity investing through his high-conviction strategy aimed at finding the superstar companies of tomorrow.
His previous fund (HCP Focus) ranked among the world’s top ten equity long-only hedge funds in 14 quarters out of the 18 quarters over the period of 1Q 2016 through 2Q 2020 based on three-year annualized returns. No other fund in this category managed to join the top ten quarterly leaderboard compiled by BarclayHedge this many times during the period.
“At the risk of sounding arrogant, the way we approach active management is how most equity managers should operate,” believes Grönblom. “Due to fear of career risk, many managers construct over-diversified closet-index portfolios. Our way involves running high-conviction, concentrated portfolios. It’s not our job to be maximally diversified. If clients want more diversification, they can easily achieve it by increasing the number of funds in their portfolios. I believe this should be the norm.” Otherwise, there are cost-effective passive instruments such as ETFs available that can provide the same market exposure as benchmark-tracking managers.
“Our way involves running high-conviction, concentrated portfolios. It’s not our job to be maximally diversified. I believe this should be the norm.”
Joined by co-portfolio manager Henri Blomster and a broader team behind the scenes, Grönblom continues to run his decade-long investment strategy under his own independent fund boutique, Asilo Asset Management, since the beginning of 2023. The equity fund Asilo Argo continues to hold a concentrated portfolio of 12 current or potential future superstar companies where the market still underestimates their competitive advantage and potential.
Idiosyncratic Strategy and Philosophy
High concentration is one of the main pillars of Asilo Argo’s investment philosophy. “A concentrated portfolio allows us more time per position or buying decision, enabling us more time and space to explore different angles to an investment case,” explains Blomster. “A concentrated portfolio gives us enough time to validate our view of the big picture and identify the aspects that are misunderstood by the market.” So, what exactly are these superstar companies?
“A concentrated portfolio gives us enough time to validate our view of the big picture and identify the aspects that are misunderstood by the market.”
“Superstar companies are a special type of companies that have distinct characteristics compared to most others,” begins Grönblom. “If everything goes as planned and expected, these are companies that can deliver returns of several hundreds or thousands of percentages.” Grönblom and Blomster aim to identify the tiny fraction of all listed companies that create the bulk of broader market returns, a discovery documented by Professor of Finance Hendrik Bessembinder. “We have a firm belief that most market participants grossly underestimate the extent of this phenomenon and erroneously assume that returns are more or less normally distributed even over longer periods,” considers Grönblom. “This is a weakness we seek to exploit.”
“Superstar companies are a special type of companies that have distinct characteristics compared to most others.”
Recent research highlights the increasing relevance of innovation-related intangibles as drivers of economic growth in recent years and decades. This environment has facilitated the emergence of superstar firms such as Google, Apple, Facebook, Amazon, and Microsoft, which dominate their markets in terms of sales, profits, and returns. Grönblom and his investors have been among the beneficiaries of this winner-takes-all market, having made early investments in Amazon, PayPal, and Facebook, to name a few.
A Slow-Traveling Idea
Grönblom believes that the concept of “slow-traveling ideas” proposed by Jack Traynor explains why market participants systematically underestimate the potential of superstar companies. Slow-traveling ideas refer to ideas or trends that take time to gain widespread acceptance and recognition. One of Grönblom’s long-held slow-traveling ideas revolves around network effects or demand-side economies of scale, which played a crucial role in capitalizing on the significant value creation of Amazon and Facebook. The Asilo team finds demand-side economies of scale intriguing for several reasons.
“First of all, network effects have a significant impact on the strategic positioning of a select few firms that enjoy truly sustainable network effects, creating and fortifying their economic moats,” states Grönblom. Second of all, with network effects being a slow-traveling idea, many market participants still vastly underestimate the power of network effects. “Surprisingly often, you can find many cases where the market underestimates the power of network effects and thus underprices the security,” says Grönblom.
“Humans are not mentally primed to intuitively grasp exponential growth or compounding growth.”
Professor of Physics Albert A. Bartlett argued that the greatest shortcoming of the human mind is our inability to intuitively understand exponential growth. Grönblom applies this conclusion to investing, stating, “Humans are not mentally primed to intuitively grasp exponential growth or compounding growth.” He further explains, “20 years ago, it was very hard for people to comprehend the potential size of a company like Amazon because it was difficult to intuitively accept the enormous numbers the company would eventually reach. I am not saying that all companies will achieve exponential growth, and only a few will sustain it for a prolonged period of time, but certain companies have that potential.”
“And what our job, to a significant degree, through studying history, economic theory, and market psychology, is to identify the characteristics that enable us to pinpoint the tiny minority of companies with the potential for prolonged exponential growth,” emphasizes Grönblom. Superstar companies share several common characteristics compared to their peers. Alongside capturing a greater share of income and outperforming peers, superstars exhibit relatively higher levels of digitization, greater labor skill and innovation intensity; and more intangible assets. “We study economic history to identify the characteristics that set these companies apart from the average or norm.”
Sector Diversification and the Importance of Valuation
Although the information technology (IT) sector commonly houses companies with network effects, Asilo Argo maintains a well-diversified portfolio ranging across various sectors, including healthcare, hospitality, transportation, consumer discretionary, and energy, among others. Network effects can be found across most sectors. “Having a diversified portfolio across different sectors was not a conscious decision, but it offers significant benefits because certain industries such as hospitality may exhibit a different cyclicality compared to sectors like semiconductors,” Blomster explains.
“Having a diversified portfolio across different sectors was not a conscious decision, but it offers significant benefits…”
Existing or potential superstar companies targeted by Asilo Argo often trade at seemingly high valuations, or rather, high traditional valuation multiples. Nevertheless, Grönblom and his team attempt to buy these superstar companies at a substantial discount to their estimated intrinsic values. “We build a comprehensive valuation model where we look at the valuation level and ask ourselves if it’s reasonable or achievable,” says Blomster. “Valuation is a crucial part of the process, but it typically comes after the security analysis and qualitative analysis.” Longer term, however, being accurate on the direction of the business is more important than the current detailed valuation. According to Keynes, “It is better to be approximately right than precisely wrong.” This very much applies when hunting for superstars.