Stockholm (HedgeNordic) – Renowned short seller Andrew Left has been quoted as saying that short sellers are becoming “a dying breed.” Despite the departure of prominent figures like Jim Chanos from the short-selling scene, Mads Thamsborg and his team at Nyhavn Capital are doubling down on short-selling. They are launching a short-focused, low-net equity fund on Sector Asset Management’s hedge fund platform. The strategy is already operational with $200 million in capital within a managed account for a U.S. investor.

“The environment has been extremely challenging for short sellers, particularly with the close to zero interest rate policies we saw for over a decade, which has driven many well-known short sellers out of the industry,” says Mads Thamsborg, former partner and head of short selling at the now-defunct hedge fund Bodenholm. “This was made worse by the meme stock squeezes we have seen over the past few years which has driven investors away from concentrated short positions,” he continues. However, Thamsborg credits this challenging environment for helping to form his approach to short selling, saying “I had to find a way to create a process that could consistently compound alpha in a very difficult shorting environment, and a key part of that was staying away from the most shorted names.”

“I had to find a way to create a process that could consistently compound alpha in a very difficult shorting environment, and a key part of that was staying away from the most shorted names.”

Mads Thamsborg, Chief Investment Officer at Nyhavn Capital.

Thamsborg brought several Bodenholm team members to Nyhavn Capital to relaunch a long/short equity strategy in 2020. Initially operating independently under a Cayman Islands structure, Thamsborg and his team have now partnered with Sector Asset Management to launch an Ireland-domiciled commingled fund that employs a more short-focused strategy. “We decided to create the right product for our team because short alpha was by far the primary source of our returns,” Thamsborg explains. “On top of that, we address a need for institutional clients by offering a strategy which is uncorrelated with other hedge funds, as most managers generate the majority of their alpha from the long side.”

“Our business model is to partner with the best investment talent. We allow them to focus solely on what they do best – investing capital – while we provide investors the comfort of multiple layers of expertise in risk management, operations and compliance.”

Wollert Hvide, Founder and CEO of Sector Asset Management.

Sector Asset Management partners with independent teams by taking minority stakes in their management companies and supporting functions beyond core investment activities. “Sector Asset Management enables fully autonomous investment partnerships to prosper,” says Wollert Hvide, the founder and CEO of Sector. “Our business model is to partner with the best investment talent. We allow them to focus solely on what they do best – investing capital – while we provide investors the comfort of multiple layers of expertise in risk management, operations and compliance,” he elaborates. Sector also supports the underlying managers with their investor relations team located in Oslo and London.

“We are therefore thrilled to establish a partnership with Nyhavn, which we believe will fit well into our diversified investment strategy range and add value to our very professional investors and partners.”

Wollert Hvide, Founder and CEO of Sector Asset Management.

With six investment partners currently on its platform, Sector Asset Management seeks to partner with independent, return-oriented investment teams running strategies that exhibit low correlation to the broad equity market. “They specialize in high value-added and focused strategies where they have an edge and can produce sustainable alpha,” explains Hvide. Sector’s main criteria for partnering with a new team include high and repeatable alpha, a strategy attractive to sophisticated institutional investors, and agreeable management teams. “We are therefore thrilled to establish a partnership with Nyhavn, which we believe will fit well into our diversified investment strategy range and add value to our very professional investors and partners.”

Nyhavn’s Short-Focused Strategy

Unlike most long/short equity players that start with a high-conviction long portfolio and then incorporate shorts and other instruments for hedging, Nyhavn Short Focused Fund takes the opposite approach. “We view ourselves as a short/long fund or an upside-down hedge fund,” explains Stephen Iklé, Founding Partner and Head of Fundamental Risk at Nyhavn Capital. “We start with the short side.” The strategy maintains about 25 concentrated short positions and a maximum of five long positions, typically between zero and two longs. “The few long ideas we have today originate from the shorting process,” explains Thamsborg. “The rest of the long book consists of instruments offering exposure to broad benchmarks, specific countries, sectors or baskets,” to achieve a net market exposure between minus ten and ten percent.

“We view ourselves as a short/long fund or an upside-down hedge fund.”

Stephen Iklé, Founding Partner and Head of Fundamental Risk at Nyhavn Capital.

Short selling is inherently risky, especially amid the recent “meme stock” activity that has triggered numerous short squeezes. Although the strategy was built to be market-agnostic, Nyhavn’s team sees a more favorable environment for short selling amid normalized interest rates. “The normalized interest rate environment is better for us,” reiterates Iklé. “Companies can no longer rely on financial engineering by borrowing at zero percent rates to buy back own shares or engage in deals or capital projects that only generate returns in a low-rate environment,” he explains.

“We expect the tails of the winners and losers to be fatter than in the past. There are fewer individuals with the short skillset to take advantage of the fatter tails on the downside.”

Mads Thamsborg, Chief Investment Officer at Nyhavn Capital.

Thamsborg emphasizes that a normalized rate environment means companies have to deliver operationally and this creates a better stock-picking environment. “We expect the tails of the winners and losers to be fatter than in the past,” he says. The dispersion among stocks is at an all-time high over the last 20 years, which means individual company correlations are at all-time lows. More importantly, “there are fewer individuals with the short skillset to take advantage of the fatter tails on the downside,” according to Thamsborg.

Avoiding the Meme Stocks

The “meme stock” short squeezes have caused significant losses for many and driven some short sellers out of business. Despite initial beliefs that the meme stock phenomenon would be short-lived, it continues to persist years later. The team at Nyhavn Capital has always avoided “crowded” shorts and developed their own unique approach to short selling. “We are different in that we don’t focus on the typical shorts, which often involve crowding around obvious structural shorts, suspected frauds, or companies with very aggressive accounting practices,” says Mads Thamsborg.

“Our performance during short squeezes has been minimally affected,” adds Stephen Iklé, the Head of Fundamental Risk at Nyhavn Capital. “Because we maintain a diversified yet concentrated short book, we don’t get caught up in short squeezes. Instead, we can use these situations to our advantage,” he emphasizes. “When we see a squeeze, we look to our watch list or current ideas and can actually add risk rather than worrying about taking risks down.”

“Because we maintain a diversified yet concentrated short book, we don’t get caught up in short squeezes. Instead, we can use these situations to our advantage.”

Stephen Iklé, Founding Partner and Head of Fundamental Risk at Nyhavn Capital.

Nyhavn’s approach to short selling focuses on what the team calls “normal” companies with a relatively positive market perception where they identify potential issues. “We look for companies where something is about to go wrong,” explains Thamsborg. “We uncover these through forensic accounting, extensive behavioral analysis, and deep fundamental work,” he elaborates. Because these companies are generally viewed positively, the team often finds an attractive asymmetry in expected returns. “This means that when we are wrong, which happens frequently, we don’t lose an arm and a leg,” says Thamsborg. However, when the team is right, the market’s surprise leads to a significant de-rating and earnings downgrades.

Nyhavn’s approach to establishing and maintaining short positions aligns with the notion that bad news tends to be more predictable than good news, and that “bad news travels slower within an organization from the bottom to the top management.” Consequently, when the management team becomes aware of negative developments, they typically address them during quarterly earnings reports. “For most companies, we can pinpoint the four dates each year when there’s a likelihood that bad news might come,” says Thamsborg. “As long as we can measure and analyze the accumulation of negative indicators and bad news, similar to a balloon gradually inflating, we can anticipate when it’s nearing bursting point and can get the timing right.” This focus on timing has led to Thamsborg’s consistent returns, with 80 percent positive quarters across many types of market environments.

“We may be seen as the ‘boring’ short sellers, but there are solid reasons for this approach. It’s not because we are boring personalities.”

Mads Thamsborg, Chief Investment Officer at Nyhavn Capital.

However, this means Nyhavn often follows potential ideas for years before initiating a position. The team also aims for a downside potential of 25 to 50 percent, whereas most remaining short sellers target 50 to 100 percent. “We may be seen as the ‘boring’ short sellers, but there are solid reasons for this approach,” concludes Thamsborg. “It’s not because we are boring personalities.”