Stockholm (HedgeNordic) – As the Chief Investment Officer of Praktikertjänst, Mattias Ledunger is entrusted with managing a pension trust that oversees the retirement funds of Praktikertjänst. The provider of private health and dental care employs a diverse range of professionals in the Swedish healthcare industry. This mainly includes doctors and dentists but also dental technicians and hygienists, physiotherapists, nurses, midwives, chiropractors, psychologists, and therapists all over Sweden.

The main pension plan, with SEK 8.7 billion under management, is no longer accepting new members and provisions, leading to reduced risk-taking requirements for managing the pension scheme. “One of the peculiarities of this pension fund is its relatively short duration and the pension fund is actually in runoff mode. It is a defined benefit plan, but no more pensions are earned under this plan,” explains Ledunger. “The duration is approximately eleven years, which is quite a bit lower than the average pension fund.”

Given the reduced risk-taking requirements, the pension fund has implemented guidelines mandating an allocation of 75 percent to bonds and 25 percent to equities with some wiggle room of plus or minus 20 percent. Despite these guidelines, the effective management of the equity portion holds significant importance in determining the prospects of pension recipients.

“We have an in-house model that supports our decisions on whether to deviate from the guideline exposure of 25 percent equities.”

The Pension Trust rarely reaches the extremes of either minus or plus 20 percent from the target equity allocation. “We have an in-house model that supports our decisions on whether to deviate from the guideline exposure of 25 percent equities,” explains Ledunger. The model takes into account the relative performance and momentum of asset classes, among other things. However, during the early stages of the pandemic, the fund significantly reduced its equity exposure and was slow to build up the exposure after that, which had a negative impact on performance. Ledunger recalls, “We were surprised by the speed and intensity of central bank interventions and the subsequent market recovery.”

180 Stocks with Long/Short Overlay

To construct their equity portfolio, Ledunger and his team have chosen a benchmark consisting of 180 names, including 150 from the STOXX Global 150 Index and an additional 30 from the OMX Stockholm 30. “Our objective is to replicate that benchmark, so the number of stocks in our portfolio will broadly be in that ballpark,” explains Ledunger. The portfolio primarily includes international mega caps and Swedish large caps.

The choice of benchmark emphasizes international diversification across industries, currencies, and regions while allowing for exposure to idiosyncratic or company-specific risks. Ledunger says, “We wanted something that was international, broad, diversified in terms of industries, currencies, and regions, but also possible to replicate.” The portfolio is managed in-house through direct investments, using a long/ short approach to adjust the weights of the 180 benchmark stocks.

“We will run an overlay of long and short positions on top of the replicated benchmark to overweight or underweight certain positions.”

“We will run an overlay of long and short positions on top of the replicated benchmark to overweight or underweight certain positions,” explains Ledunger. “There will be names, especially Swedish ones, that can have a significant weight in the benchmark,” says Ledunger. “We tend to take somewhere between one and two percentage points up or down to overweight or underweight certain stocks.” His investment team will not run this long/short overlay to each individual position, however. “On top of the 180 long positions in each individual company, we will run an additional ten to 15 long and short positions to adjust the weights in the portfolio.”

Same People for Asset Allocation and Security Selection

The investment team of four professionals, including Ledunger, analyzes and looks for investment cases to adjust the weights in the 180-name portfolio. While each team member has a slightly different investment style, the overall approach tends to be value-driven, with a focus on avoiding value traps. “The investment style is going to be colored by the individual. Most of us, however, tend to be a little value-driven,” explains Ledunger. “We are old enough to be aware of our limitations in investing, so we really try to screen hard in order to stay out of value traps.”

“The investment style is going to be colored by the individual. Most of us, however, tend to be a little value-driven.”

The team conducts thorough evaluations and relies on third-party research to document their decisions. “The decision-making process involves in-depth evaluation, and we look for triggers to support our choices,” says Ledunger. “We don’t want to have something that can be undervalued for a very long time, or forever.”

The investment team not only manages individual positions within the portfolio but also focuses on top-down allocation, macroeconomic conditions, and strategy. “The team tends to always put a lot of effort into the top-down allocation, macro environment, and strategy,” says Ledunger. “This process often involves decisions on asset allocation, duration decisions, how the curve will develop, and credit conditions in general,” he elaborates. “But then we are also the same people who then take on different positions. The trick is to be disciplined and only take the risks that we can manage with the people we have.”

Views on the Economy

Ledunger acknowledges the importance of the economic outlook in predicting equity market movements. To predict where equity markets might be heading, “you are going to have to start with the economy,” begins Ledunger. He suggests that a recession seems likely due to various factors such as rising rates, banking crises, debt ceiling issues, contracting credit conditions, high market valuations, and geopolitical tensions. “Everything is in place for recession, but it has not really happened yet. There is a pretty fair chance that we are going to see a recession. And if we do, we are going to see earnings contract.”

In the current uncertain environment characterized by war, high inflation, and debt ceiling concerns, Ledunger maintains a slight short exposure in the S&P 500, resulting in an equity exposure of 23 percent. The fund also implements a “risk-reversal” options overlay as a precaution against potential market downturns. “We would rather be flat at delta one with an exposure of 25 percent, but then put that option overlay on for a little protection.” When earnings turn down, Mr. Market is always panicking and selling, according to Ledunger.

“The signals that flash red could potentially, for the first time, not lead to a recession.”

Ledunger also acknowledges the possibility of avoiding a recession or experiencing a mild one, considering the substantial stimulus injected into the economy and markets by central banks and governments worldwide over the past decade, peaking around the Covid pandemic. “Trying to find how we are wrong, I would have to be open to a scenario where the lingering effects of these measures, such as the substantial injection of cash into the hands of consumers and businesses, could sustain strong consumption and robust employment through the industrial supply readjustment that normally spells recession,” says Ledunger. “The signals that flash red could potentially, for the first time, not lead to a recession,” he emphasizes. “This is uncharted territory.”

Even so, chances are that markets are going to experience a landing. “Even if it is just a soft landing, earnings are going to come down,” he argues. Given his view of the stock market being overvalued, Ledunger and his team have taken protective measures and are prepared to increase their selling activities. On the depth of any drawdown, however, he adds a caveat. “There is a risk that the recession and drawdown will be truncated because you can’t underestimate the possibility of central banks becoming hyperactive again, despite their claims to the contrary. A lot of people are counting on the Fed put.”