Despite the relatively young age of Formue Nord Markedsneutral (Market Neutral), the three-person team has developed a market-leading position within its niche. This has led to good returns with low correlation to the market and so much investor interest that they had to temporarily close for new subscriptions.
Chief Investment Officer and co-founder Rasmus Viggers talks about what they invest in, how they do it, and why it’s attractive.
The investment strategy
The special situation fund has a focused but flexible niche investment strategy. Viggers explains: “We take a very specialized and narrow approach to certain market niches. The main niche is financing of listed micro-, small- and mid-cap companies in the Nordics. As an example, we are the most active and experienced professional participant in rights issues within our area. We participate in rights issues in several ways, the most common being underwriting (guaranteeing) part of the issue. We also buy subscription rights in the market and exercise them, take part in overallotment options, etc.”
Another key pillar in the investment strategy is to deliver returns with no correlation to the overall stock market. As Viggers puts it: “Formue Nord Markedsneutral has a beta-target of 0. When we take exposure, we simultaneously estimate the beta of a given investment and neutralize the beta through futures and options. This means that investors in Formue Nord Markedsneutral can use the fund as a risk-diversifying part of their portfolio. A great example of the value in our beta neutrality is our results in 2018 – net returns of +13.6% while stock markets were suffering. On the other hand, this also means that we don’t get a free ride in a bull market.”
The investment approach has gradually been developed and refined for years and is still an ongoing process. Viggers started to participate in capital-related events in listed companies when he was 17 years old. He first noticed good risk/return possibilities in mispriced subscription rights related to a rights issue: “I could buy subscription rights for 0.1 SEK, exercise the right to subscribe for a new share in the relevant company for 3 SEK, and the existing share might be trading at SEK 4 at the same time.”
After investing his own money for several years with good results, he decided to test whether there was some kind of anomaly in the area or if he had simply been lucky. He wrote his award-winning master’s thesis on the subject and ended up implementing the strategy at the asset management firm he worked at before co-founding Formue Nord.
A high number of deals and transaction are assessed each year. In 2018, Formue Nord participated in more than 100 transactions. The types of investments vary and have developed over time to become more specialized. As Viggers explains: “When we launched Formue Nord Markedsneutral, we tried to allocate capital to as many interesting strategies as possible, in order to increase the diversification in the fund. Now we are more focused on the financing niche and try to increase the diversification within it, but at the same time increase the fund’s exposure to this niche.”
On the different types of investments and the development, he says: “Historically our main activity has been underwriting rights issues. However, the financing market is constantly moving, and we try to adapt and evolve with it. As an example, we have recently had larger than average exposure towards direct loans to companies. This development is a result of the declining stock market in late 2018, which prompted a postponement of rights issues and thus increased the need for short-term capital through direct loans. In periods with more volatile markets we also normally have higher exposure to rights that we pick up and utilize because the spreads are widening.”
Besides the investments in special situations, Formue Nord has a relative value basket where they can place positions that they believe are heavily underpriced for the medium term. This might be stocks accumulated in issues, or other assets they believe to be mispriced. This basket is limited risk-wise compared to the activity in special situations.
An example of an unusually low-risk rights issue underwriting
The rights issue by the football club Brøndby IF is an example of a successful and very low-risk underwriting by Formue Nord Markedsneutral. Usually, the risk is higher, but it shows that you can find great deals if you do the work.
With the aim of becoming debt-free, Brøndby IF decided to issue new equity with a value of up to DKK 140 million. To secure a minimum subscription of at least DKK 100 million, a consortium of underwriters was set up. Major shareholder Jan Bech Andersen also committed to participate in the issue.
The participation by existing shareholders was not large enough to reach the guaranteed DKK 100 million, meaning that the underwriters had to buy shares. Formue Nord knew in advance that if the guarantee was called, Jan Bech Andersen’s stake in the company would go above the 33 percent threshold that required him to put in an offer to other shareholders to buy their shares at a price equal to the issue price.
Formue Nord was guaranteed to be able to sell its shares at the purchase price and still get their commission. If the share price increased following the issue, they still had the upside, but if it fell, they had the option to sell without a loss. The only risk in this investment was that the main shareholder wasn’t able to fulfill his obligation. In case the issue had been fully subscribed, they would still get the commission without having to buy any shares.
Investing in and guaranteeing rights issues
When listed companies need additional capital, they can raise it through a rights issue. Usually, the current shareholders get the chance to participate in the issue at a size proportionate to their existing shareholdings. They can choose to subscribe to the issue and buy new shares in the company, they can ignore the issue, or they can sell their rights to other investors.
To guarantee that the funds sought by the company will be raised, it can use underwriters. If the rights issue is not fully subscribed, the underwriters are obligated to buy shares up to the amount they have guaranteed. The underwriters will get a commission for this guarantee and will get paid whether the guarantee is called or not.
Below is an example of an underwriting commitment from the 2018 Savosolar rights issue. The underwriters got a commission equal to 10% of the amount they guaranteed or 12% if they chose to be paid in shares. If the rights issue was less than 80% subscribed, the underwriters were required to buy shares up to the guaranteed amount allocated on a pro rata basis based on their share of the guarantee.
Terms of the underwriting commitments from Savosolar’s 2018 rights issue prospectus
The attractiveness of the niche and Formue Nord’s competitive advantage
Few people devote a lot of attention to this niche, and this can be exploited by those who take the time and have the skills. Viggers explains: “I think our niche is attractive because the transactions we take part in are often extremely complicated. We have deep specialized knowledge in this field, and we have done so many transactions by now, that we can process a very complex situation in this field very quickly.”
According to Viggers, Formue Nord also benefits from its size and flexibility: “One of our advantages is our size. We have a large enough size to carry some clout in these transactions, but at the same time, we are not large enough for the transaction in the micro-, small-, and mid-cap area to be insignificant. Another advantage is our flexible mandate, which allows us to evolve with the market and customize the solution to each company.”
Formue Nord also benefits from the reputation and track record it has built in the market. Corporate finance advisors will contact them directly with relevant deals. “We try to be of as much value as possible to the advisors and issuers by being flexible and giving input when we can. In return, we hope to be invited into as many transactions as possible” Viggers says.
The large number of deals and the research they have done also gives them an informational edge. They have built a proprietary database with relevant information regarding their niche. Even though they value their Bloomberg terminal, a lot of information cannot be found here in the small- and micro-cap space.
What to look for in rights issues
There are a number of factors to consider when participating in or underwriting rights issues. Viggers goes through some of them:
“There are many factors to take into consideration, and one characteristic cannot stand alone. The puzzle has to add up in the end. One key factor is the ownership structure. If there are one or more large owners, it’s important to know how they will act in the issue. If they commit to exercising their pro rata part of the issue, that’s a great sign. If the ownership is spread across many smaller investors, that can also be a good sign for the transaction, as they are more likely to have the funds needed to back up the transaction and more investors will evaluate a potential oversubscription.”
“Another important factor is the level of underwriting. We generally prefer underwriting up to around 80% of the issue, because this ensures that everyone is motivated to make the transaction successful. Another factor is, of course, the subscription price of the new shares to be issued. Is the discount large enough for the issue to be attractive? If not, chances are high of the underwriting coming into play. Also, the markets current perception of the company is very important. I could go on, but really, it’s all about the individual case and tailor-making the transaction to suit the company.”
Market correlation and risks
A key selling point of the investment strategy is the low correlation to the market. Since its inception, the fund has had a correlation to the stock market (MSCI World) of 0.03. Viggers explains how they manage the correlation: “Everything we do is connected to a listed company, so naturally there will be some degree of correlation between our investments and the stock market. With our beta target of 0, we have to estimate the beta of the portfolio and eliminate it. We do this by shorting equity index futures for beta hedging and by buying out of the money put options for gamma hedging. So far, we have done an excellent job of neutralizing the stock market exposure”
On the risks, Viggers says: “Our current strategy has not yet been tested in an extensive market crash, so one risk is that our hedges won’t work optimally in such an event. We are very aware of this risk and try to hedge the portfolio the best we can, but the truth is that black swan events can impact any strategy in an unforeseen way.”
“On a company-specific level, we have great diversification with normally max exposure of around 5% of our equity. This means that if for example a direct loan defaults, the drawdown would be maximum 5%. The same applies for a new issue, if we just got a 5% equity stake and the company defaults the day after.”
When asked about cases with a big negative impact or where a large part of the guarantee got called, Viggers says: “There are several cases but that is a natural part of the strategy, and also why we limit exposure in any given company to 5% of our equity. Recently we have been allocated in excess of 70% in more than one of our underwritings, so now we have to maneuver in the market and reduce exposure with limited price impact. We have extensive experience in trading these smaller names, and in general, we are patient when it comes to de-risking through the market. In fact, this is also one of our advantages. Our experienced patience is rewarded by us being invited back into the next transaction.”
Formue Nord is based in Aalborg, Denmark. It was founded in September 2015 by Rasmus Viggers (CIO) and Thøger Dam Johansen (CEO). The third team member, analyst Mikkel Hagel, joined at the beginning of 2017.
Formue Nord is an independent asset manager majority-owned by Viggers and Johansen. Some seed investors also got equity stakes in the company. The two founders invest their own money in the fund on the same terms as its clients to make sure interests are aligned.
Since its inception, Formue Nord Markedsneutral has made an 8.4% annual return with a market correlation of 0.03. In the first two month of operations the fund had full market exposure. During its beta-neutral period, starting Feburary 2016, the annualized return is 13%.
Formue Nord Markedsneutral performance since inception
The fee structure is based on a 1% fixed fee and 20% performance fee. The minimum investment is DKK 1 million. To protect existing investors, Formue Nord closed the fund for new subscriptions in April 2019 as they experienced a rapid increase in monthly subscriptions. They expect to open the fund again at a later stage.
Besides Formue Nord Markedsneutral, they run two other strategies. Formue Nord Globale Aktier (Global Equities) aims to select the 20–25 best equities from a gross list of equities held by leading investors such as Warren Buffett and Sequoia. Formue Nord Fokus offers long-term financing solutions, often revolving around convertible bonds.
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