Stockholm (HedgeNordic) – Ola Björkmo and Jonas Sandefeldt had been running a systematic market-neutral strategy focused on capturing fundamental momentum for over a decade before relaunching the strategy under the Meriti Capital umbrella in late 2023. The process of transitioning the strategy into a new UCITS fund structure provided them with an opportunity to reflect and refine the strategy for its new phase. Meriti Neutral now stands out as “one of the few true market-neutral funds available in Sweden, and the only Swedish equity market-neutral systematic fund in a UCITS structure that we know of, making the strategy unique,” according to Ola Björkmo, CEO at Meriti Capital.

The duo managed the QQM strategy for 13 years, employing a systematic approach to construct a market-neutral portfolio of about 200-300 individual long positions and a similar number of short positions. Their goal was to capitalize on shifting fundamental momentum based on analyst expectations. Björkmo describes the strategy as akin to trend-following, but with a twist – rather than tracking price trends, they focus on fundamental trends.

“One of the few true market-neutral funds available in Sweden, and the only Swedish equity market-neutral systematic fund in a UCITS structure that we know of, making the strategy unique.”

Ola Björkmo

“Historical performance is of little concern to us, the trends are always forward-looking, and we focus on forward estimates,” explains Björkmo. “We know that fundamental signals are a very powerful predictor of future returns, so we use different signals and indicators on profitability, analysts’ up and downgrades to identify companies for either positive or negative shifts in fundamental momentum.”

Refinements

The duo continually honed the strategy throughout their journey, making further refinements for the version operated under Meriti Neutral. “We have made quite a few changes to the model over the years,” says Sandefeldt, Head of Systematic Management at Meriti Capital. The strategy deployed by Meriti Neutral embodies the 2.0 iteration, aimed at delivering a stream of returns that remains uncorrelated with traditional market movements.

“One of the changes we have implemented is to use volatility-based weights, ensuring that positions with equal signal strength are allocated the same risk budget on a risk-adjusted basis.”

Jonas Sandefeldt

“One of the changes we have implemented is to use volatility-based weights, ensuring that positions with equal signal strength are allocated the same risk budget on a risk-adjusted basis,” Sandefeldt highlights one of the strategy’s modifications. Previously, certain highly volatile stocks tended to exert disproportionate influence on the fund’s performance. By scaling each position based on expected volatility, Sandefeldt anticipates that this new methodology will “mitigate the volatility of the fund’s returns without compromising expected returns.”

“Another notable change is our increased emphasis on sector neutrality, in addition to market neutrality,” continues Sandefeldt. Previously, the portfolio management team focused on building market-neutral portfolios across eleven distinct European countries to ensure that no country exposure disproportionately impacted returns. The team has now opted to integrate sector neutrality into their approach. 

“Another notable change is our increased emphasis on sector neutrality, in addition to market neutrality.”

Jonas Sandefeldt

“At times, significant fluctuations can occur within a single sector,” says Sandefeldt, noting that while the net allocation seldom exceeded 15 percent in any one sector, extreme movements within a specific sector could significantly influence performance. To isolate fundamental momentum at the company level, “we now seek long exposure to the best stocks in every single sector and short exposure to the worst,” states Sandefeldt. “By introducing sector neutrality and restricting exposure per sector, we expect to get a smoother return series going forward.”

The Biggest Refinement of All

Another significant change that can have a significant effect on Meriti Neutral’s return profile is the management of its cash reserves. “Given our market-neutral approach, we are always ‘cash rich’ and a third change is the active cash management,” notes Ola Björkmo. Approximately 15 to 20 percent of the fund’s cash is utilized as collateral for short positions via total return swaps, while the remaining portion is allocated to a new corporate bond portfolio strategy. This shift not only represents a change in the cash management approach but also leverages the expertise and experience brought by Meriti Capital. Gustav Andåker, Head of Discretionary Fund Management, has been tasked with overseeing the cash component of the portfolio.

“Given our market-neutral approach, we are always ‘cash rich’ and a third change is the active cash management.”

Ola Björkmo

In general, market-neutral strategies derive returns from three primary sources: the actively managed long and short positions, as well as the cash component. “With Gustav Andåker managing that part of the fund, we have a skilled bond trader that will add extra yield to the strategy, improving the fund’s risk and return profile,” highlights Björkmo. “Given that we incur costs associated with short positions, typically based on Stibor plus a certain number of basis points, our aim in managing the cash portfolio is to target a slightly higher margin than what we pay on the shorts,” further explains Sandefeldt.

“With Gustav Andåker managing that part of the fund, we have a skilled bond trader that will add extra yield to the strategy, improving the fund’s risk and return profile.”

Ola Björkmo

Previously, at QQM, the team primarily allocated the cash to government, municipal, and covered bonds. However, this approach resulted in very low returns on the bond portfolio. “Essentially, we found ourselves in a situation where the returns from the bond portfolio were insufficient to cover the costs associated with the short positions,” says Sandefeldt. “Now, our focus is on generating additional returns from the cash portion of the portfolio. We anticipate that our new active bond picking approach will yield incremental returns ranging from half a basis point to one percentage point per year, on top of what we pay for the short selling,” he continues. This shift is expected to enhance Meriti Neutral’s overall returns in the future.

The implementation of the new active bond-picking approach is expected to not only generate additional returns but also enhance the fund’s performance across various market conditions. Sandefeldt recalls one of the drawbacks of the QQM strategy, noting that “even though we had an estimated beta very close to naught, the fund had a negative beta when equities had a very strong month.” According to Sandefeldt, “some of that negative beta will be offset by the bond portfolio since corporate bonds have some correlation with the stock market.” Moreover, Sandefeldt expresses confidence that the low correlation between the market-neutral portfolio and the bond portfolio will persist in the future.

Diversification Benefits

Despite improvements in managing the fund’s cash allocation, the primary driver of Meriti Neutral’s returns remains its quantitative strategy that captures fundamental momentum. As a market-neutral strategy, the team aims for zero correlation with broader equity markets. “From a diversification perspective, we can guarantee that the fund will diversify a portfolio,” concludes Björkmo. “The fund has a correlation of nil to both equities and bonds. We see that most investors will benefit from including the fund in their portfolio. The fund will diversify the investor’s portfolio regardless of current exposure,” he continues. This allows investors to maintain a larger position in equities or other riskier assets while retaining the same level of risk in their overall portfolio.

This article is part of HedgeNordic’s Nordic Hedge Fund Industry Report.