Stockholm (HedgeNordic) – The outbreak of the Covid-19 pandemic triggered a violent market crash back in early 2020, which, assuming perfect foresight, presented a dearth of attractive investment opportunities across many asset classes. Norwegian asset manager Borea Asset Management swiftly launched a special fund in September of that year to capture a set of attractive risk-reward opportunities within the Norwegian banking sector. That fund, Borea Utbytte, was last year’s best-performing member of the Nordic Hedge Index with a full-year return of 61.8 percent.

The background behind the launch of Borea Utbytte launch goes a few years back. “Our experience in the banking sector goes back around eight years, when we started with a discretionary mandate for a client who was interested in hybrid capital,” starts portfolio manager Magnus Vie Sundal (pictured). In mid-2019, Borea Asset Management launched Norway’s first fund solely investing in Additional Tier-1 (AT1) – also dubbed hybrid – securities issued by the approximately 100 Norwegian savings and commercial banks.

Borea Obligasjon returned 8.7 percent in the pandemic-hit 2020, as the Borea team acquired hybrid debt securities yielding as much as 14 percent, in the depths of the first-quarter market crash. While AT1 securities repriced quickly in the months that followed, “we noticed a substantial mismatch between equity pricing and hybrid capital pricing,” according to Sundal. The Borea team moved quickly to launch Borea Utbytte, to capitalize on that mismatch.

“It was a bit lucky that we nailed the timing of the launch, but at the same time, we saw an opportunity and we grabbed it.”

“We launched Borea Utbytte on September 30, and October was a negative month, one of the few negative months we have had with this fund,” Sundal recalls the early days of Borea Utbytte. Then came November, when Pfizer announced promising news on their vaccine. “That was a factor that sparked a rally in these sectors that had been suppressed for a while,” he continues. “It was a bit lucky that we nailed the timing of the launch, but at the same time, we saw an opportunity and we grabbed it.” Borea Utbytte went on to return a cumulative 89 percent since its launch.

Broad Mandate

Structured as a Norwegian special fund, Borea Utbytte has a broad mandate on paper, but not in practice, according to Sundal. “While we aim to retain flexibility, we also aim to be a boring fund most of the time. We like to compare ourselves to the “tortoise and the hare,” says Sundal. “We are long-only 95 percent of the time, looking to capture the benefits of long-term exposure to Norwegian macro risk,” continues the portfolio manager.

“While we aim to retain flexibility, we also aim to be a boring fund most of the time. We like to compare ourselves to the “tortoise and the hare.”

For managers looking to sell stocks short in the Norwegian banking sector, there are liquidity constraints in this market that limit the short selling the stocks of “a few handful of the biggest banks,” says Sundal. “We would engage in short selling only when we turn very skeptical on the banking sector as a whole.”

The special fund structure enables the team running Borea Utbytte to leverage up to 150 percent of the fund’s assets under management. “We can borrow up to half of our assets under management, but in normal times, we run with a net market exposure of between 115 percent to 120 percent,” says Sundal. “Given that the pricing has come up significantly in the banking sector, we are closer to 100 percent for the time being.”

Opportunity-Grabbing Borea Utbytte

Although Borea Utbytte was initially put on the market as an opportunity-grabbing fund, portfolio manager Magnus Vie Sundal still believes in both the short-term and longer-term return potential of the fund and its sector focus. “When we started the fund, the average price-to-book value was about 0.8 in the Norwegian banking sector, now it is around 1.35, and the historical average is slightly above 1,” says Sundal. “This metric peaked around 1.9 pre-financial crisis. How expensive banks shall become this time, depends on the yields of alternatives. With current underlying performance, we do not believe banks are too expensive.”

“How expensive banks shall become this time, depends on the yields of alternatives. With current underlying performance, we do not believe banks are too expensive.”

Despite the Norwegian banking sector trading at a high price-to-book level, the sector still has more to offer in today’s market environment, according to Sundal. “The average Norwegian commercial and savings bank gives investors a return on book equity of 11 percent,” he explains. “Even at today’s pricing of 1.4 times book value, the sector offers an earnings yield of around 8.0 percent, which is very attractive compared to many of the alternatives.”

Long-Term Case for Norwegian Banks and Borea Utbytte

“The banking sector, at least historically, has gone in cycles, and we jumped on an opportunity that we saw in the market,” reiterates Sundal. “We got on a good part of the cycle, so we had the stellar return last year of about 62 percent,” he continues. “But one of the reasons we really wanted to start this fund as a long-term product is that Norwegian banks have performed very well over a very long period of time.”

“The banking sector, at least historically, has gone in cycles, and we jumped on an opportunity that we saw in the market.”

Borea Utbytte’s bank-focused benchmark has generated an annualized return of about 14 percent since the start of the millennium, compared to a 9 percent annualized return for the broader Norwegian stock market. “While 14 percent seems unlikely going forward we still believe the Norwegian banking sector will continue to outperform also the future.” Sundal argues that Borea Utbytte is supposed to be boring. “Many years, the fund will be in the shadows of booming stock markets or more in-vogue ESG or energy stocks, but over time, we expect the sector to outperform the broader market.”

“Many years, the fund will be in the shadows of booming stock markets or more in-vogue ESG or energy stocks, but over time, we expect the sector to outperform the broader market.”

“When it comes to the Norwegian banking sector, there is one element that is under communicated or not understood well enough,” highlights Sundal. “Banking is really about macro risk. As long as businesses and individuals manage to service their debts, pay on their mortgages and their loans, the sector as a whole will do well,” elaborates the portfolio manager. “We may have a concentrated economy on energy, but we do have a reserve fund, the oil fund, that gives us the confidence that things will work out well,” says Sundal. “We are not saying that stockholders should rely on the government to be the lender of last resort, but we do have a lot of tools in Norway to handle macro risks and support the economy with fiscal stimulus through challenging times. That greatly benefits the banking sector.”