Sissener Canopus: Dynamic Long/Short Equity and Derivatives
Global investing through a Nordic prism
Sissener Canopus has repeatedly received The Hedge Fund Journal’s ‘UCITS Hedge’ award for best risk adjusted returns in the global equity long/short category. From inception in May 2012 to the end of 2019, it annualized at 13.5% with volatility of 9.7%. Historically, there has been an average net long exposure of 68%, and alpha on the long book has been the main driver of returns. But in March 2020, for the first time ever, the strategy went net short, as put option protection kicked in. In broad brush terms, portfolio hedges made around 16.2% in the first quarter of 2020, covering roughly half of long book losses of 32.9%. “In hindsight, we should have had more protection. But buying out of the money put options in February reduced volatility,” says co-portfolio manager, Bjørn Tore Urdal.
This was not the only example of dynamic management in February. In common with many discretionary fundamental managers, Sissener started 2020 with a constructive outlook on the global economy and cyclical companies, based on improving manufacturing and PMI data. Sissener had anticipated some rotation from growth into value cyclicals, but this wager was largely unwound as the macro view was reassessed in February. The move was well timed, as value has underperformed by a massive margin in March and April 2020.
Rather than focusing on exclusion, we prefer to view ESG as a source of alpha. The EU taxonomy rules kick in next year, so capital will increasingly flow into companies that are compliant.
Bjørn Tore Urdal, co-portfolio manager, Sissener Canopus
As of May 2020, the multi-year outperformance of growth and quality factors has extended further, partly because the coronavirus pandemic amplifies trends towards digitization, but also because any company that can grow earnings commands a scarcity premium in a contracting global economy. US market leadership, concentrated into five technology firms, is narrower than ever. Sissener has owned FANG names before and currently technology exposure includes local firms.
One is Norway’s Trondheim-headquartered Nordic Semiconductor, which is nearly back to its all-time highs after a 50% drawdown in March. Coronavirus has also led to an explosion of interest in another example of innovation in Norway: videoconferencing technology, where Norway’s Tandberg, which was bought by Cisco ten years ago, was an early mover. The former CTO of Tandberg left Cisco to become CTO of a new firm in the space, Pexip, formed from video infrastructure group, Pexip, and cloud video service provider, Videxio. “Its offering includes enterprise and cloud-based videoconferencing that interfaces with multiple other technologies, such as Skype or Microsoft Teams. It has a strong subscriber base and business model based on a large global footprint, with 97% of its customer base being blue chip customers,” says Urdal. Pexip is also perceived to be more secure than some rivals. In May 2020, Sissener was lucky enough to receive a pre-IPO allocation to the Pexip flotation, which jumped 40% on its first day, valuing the firm at over US$1 billion.
Sissener is also foraging locally in oil equities. “We see potential for the oil market to rebalance by the third quarter, and oil prices could be higher than predicted by the future curve. But this is already factored into the share prices of many E&P names. And more oil majors could follow Equinor and Shell in cutting dividends if oil stays below the high 40s. But we are confident that pure oil producer, Aker BP, can maintain its output and dividend. We also find Subsea 7 is a unique specialized oil services play with few competitors. It has net cash on the balance sheet, is winning new contracts and has a very solid backlog of older ones. We also own its corporate bond, which is collateralized by the Chairman’s equity holdings,” says Urdal.
In chemicals, the story is also more stock specific than thematic. “Fertiliser producer Yara benefits from lower natural gas prices but is primarily a play on its restructuring strategy to sell assets and return free cash flow to investors through buybacks or dividends or both,” explains Urdal.
Sissener Canopus has repeatedly received The Hedge Fund Journal’s ‘UCITS Hedge’ award for best risk adjusted returns in the global equity long/short category. From inception in May 2012 to the end of 2019, it annualized at 13.5% with volatility of 9.7%.
Another Norwegian large cap stock held is insurer Storebrand, which is growing market share outside Norway in Denmark and Sweden. Insurers are partly an inverse play on higher interest rates, which would reduce the value of their fixed liabilities. “But even at current rates near zero, the firm is fully capitalized. And longer term, the firm is growing its non-guaranteed portfolio,” says Urdal.
Thus, while Canopus has a global mandate, it finds many opportunities in the local market: Nordic equities made up around 76% of the long book in April 2020. Sissener takes pride in deep local knowledge. “With fewer analysts covering more companies, MiFID II has generally reduced the quantity and quality of sell side research coverage. The cutbacks have been most marked for smaller companies where there is more coverage of highly indebted firms, which might generate more issuance business for brokers. This may lead to questions about the objectivity of the research. However, as Nordic specialists, we have great access to local companies via the local brokers we spend money with. This gives us a competitive edge and limits outsiders from accessing the research,” says Urdal.
Outside the Oslo market, Sissener has held UK listed insurer, Prudential, for many years, based on the Asian growth story that has recently attracted Third Point activist, Dan Loeb, to agitate for a spin off of the Asian unit.
On the short side, Sissener has had both popular and contrarian short exposures, inside and outside the Nordics. Tesla is a relatively crowded short, and Sissener has lost on its put option exposure. In contrast, it has profited from shorts in Disney and McDonalds in March. A recent contrarian short, which has relatively low short interest of only 4%, has been Hilton Hotels. Another non-consensus short position was taken in Finnish lift maker Kone, based on an event-driven thesis: Sissener accurately anticipated that Kone would not win an auction for Thyssen Krupp’s elevator business, and this disappointment led the stock to swoon by 15%.
ESG will become more important over the next year or two. Sissener are UNPRI signatories, members of NORSIF, and have observed the Norges Bank exclusion list of over 100 companies since 2012. (Reasons for exclusion include producing nuclear weapons, cluster munitions, tobacco, coal or coal based energy; causing severe environmental or unacceptable greenhouse gas emissions; gross corruption, severe violations of human rights or of individuals’ rights in situations of war or conflict, or severe violations of fundamental ethical norms).
But all of that is becoming quite common, particularly in the Nordics. It is stock picking that differentiates Sissener’s ESG approach. “Rather than focusing on exclusion, we prefer to view ESG as a source of alpha. We are seeing real opportunities to generate alpha from ESG based on capital flows. The EU taxonomy rules kick in next year, so capital will increasingly flow into companies that are compliant. We have already taken positions and will continue to do so. Many companies are “greenwashing” but we want to find those taking proper steps towards becoming green. An example could be firms shifting from coal to hydro power generation,” says Urdal. Recent long positions that could be perceived as “impact investing” names include emerging markets power plant operator, Scatec Solar, and Energy Recovery, which promotes energy efficiency through several technologies that capture energy produced in energy, chemical and water industries.
But Sissener applies the same valuation disciplines to such names. “Some of these firms are likely to become overvalued,” says Urdal. Indeed, Sissener has sometimes held short positions in stocks with high ESG scores, such as Finland’s renewable energy maker Neste Oil.
A return of value investing is a question of when not if.
Bjørn Tore Urdal, co-portfolio manager, Sissener Canopus
Capital structure arbitrage
Long/short equity forms the bulk of the strategy but Canopus is active elsewhere in the capital structure, up to a maximum of 20% in corporate bonds. For many years, Canopus has pursued a capital structure trade of owning distressed bonds against a short in equity, in a number of companies. This has most recently been done in Norwegian Air Shuttle, before it carried out a debt for equity swap and a share sale. “We bought the convertible bond at 10 cents, which has, via the debt for equity swap, converted into equity at a price of NOK 3.80, giving an effective cost per share of 38 cents,” says Urdal. One advantage of structuring the trade using convertibles is that they provide equity to deliver against, and close out, the short position.
Trading options from both sides
Directionality has been scaled back as Canopus has moved to a cautious 22% net long in April, and as options exploded in value, Sissener has been selling some put options on solid, defensive companies that have limited Covid-19 impact, as a way to monetize high implied volatility. Canopus is also selling straddles designed to profit from its expectation of a range-bound market. “Upside is capped by valuations, which are looking lofty even on 2021 earnings estimates, but downside is backstopped by government fiscal and monetary stimulus. This straddle could become a fairly big driver of returns. We have been active in options as an integrated part of the fund strategy,” explains Urdal.
Ready to rotate
Sissener is cautiously positioned but is, at some stage, ready to rotate back into the reflationary and value-oriented equities that it started 2020 with. “A return of value investing is a question of when not if. We need to work through the current deflationary environment and see inflation, rising interest rates, rising wages, and lower unemployment. It is hard to say when this may happen, given the uncertainties around the macro outlook. But it might even occur before year end,” says Urdal.
Sissener Corporate Bond Fund: Nimble trading and conservative name selection
Sissener’s Corporate Bond Fund launched in March 2019 and had a baptism of fire on its one-year birthday. The turbulent month of March 2020 has provided a useful stress test for portfolio and fund liquidity, and opened up a compelling opportunity set. The fund has capitalised on the sell-off, recouped its drawdown and is up 1.46% for 2020 as of 8 July.
“The strategy experienced a cash call of 35% over the month. Some 20% of this was to cover currency hedges as the Norwegian Krona crashed by 30% against the USD, Euro, and SEK in two weeks. The hedge is normally rolled every three months. The fund also received redemption requests of about 15%,” says manager, Philippe Sissener.
Meanwhile, bid offer spreads blew out from their usual 1 or 2 points to as wide as 10 points or even more, in cases where two-way quotes could be found. Sometimes, there were simply no bids. Administrator, EFA, was able to price the fund each day nonetheless, whereas a number of credit funds in the Nordic region suspended dealing. Sissener had no problems with either valuation or dealing, and paid redemptions on time. “We kept around 5% in cash to manage withdrawals, subscriptions, and margin calls on the FX forwards. The fund also held some shorter dated bonds as a liquidity buffer,” says Sissener.
Sissener managed the cash demands by initially selling shorter dated and more liquid bonds and switching into longer dated paper that had fallen further. This was a tactical move in March and by April the strategy soon reverted towards a shorter duration stance. By early May, liquidity was getting back towards more normal levels, but the macro outlook warrants very careful name selection.
The uncertainties around economic recovery are too great for Sissener to have much confidence in whether it might follow a ‘V’, ‘W’, ‘U’, ‘L’ or Nike Swoosh shape. “Nobody has a real understanding of how recovery will play out. It is best to be mentally prepared for market direction versus fundamentals, rather than mentally binding to a particular shape of recovery. So much depends on consumer behaviour and savings rates, corporate behavior and investing,” says Sissener.
Nonetheless, Sissener reckons the asset class is reasonably attractive as of early May. “High yield bonds are paying 10% in local currency with NIBOR interest rates at 0.3%. Going into the crisis, they paid 6% versus rates at 1.7%. Therefore, credit spreads have doubled, and even assuming a 7% default rate with 30% recovery rates, the asset class might return as much as 5%,” adds Sissener.
Of course, being active managers, Sissener will aim to outperform the index and avoid defaults in this fund. (The Sissener Canopus capital structure arbitrage trade of buying distressed bonds and shorting equity of the same company has often profited from defaults, but the Corporate Bond strategy focuses on performing credit.)
“In early March, we sold anything travel-related, including airlines, hotels and hospitality. There is no visibility on travel or tourism. Behaviour may change if people realize they do not need to make a one-day business trip to London. Having previously invested in high yield, we are now finding good risk/reward on crossover investment grade names, getting paid well while waiting for spreads to normalize. We are sticking to somewhat shorter maturities with an average duration of two years, though we have some higher quality names of 5-6-year tenor,” says Sissener.
Country exposures are probably over half in Norway, though it does depend on how the domicile of international companies is defined. There is some exposure in Sweden and Finland, and the mandate can allow for a sleeve in US or European companies. For instance, Euronav issues bonds in NOK quoted on the Oslo market to cater for local investors with a focus on shipping.
The energy sector is the largest weighting, though this is not pure oil. It includes both oil and oil services, as well as utilities involved in solar and wind farming.
Public sector asset purchases
The Federal Reserve and ECB have been buying investment grade corporate debt for some years, and the Fed has in 2020 announced it will start buying high yield for the first time. Issues from Nordic companies are not expected to be eligible for either programme. But a Norwegian state pension fund (separate from the oil fund), The Norwegian State Bond Fund (Statens Obligasjonsfond), could spend up to NOK 50 billion buying bonds, with up to 50% allocated to high yield from BB+ all the way down to credit ratings of CCC+. There is even potential for it to hold some distressed and defaulted paper: it cannot initiate a position in bonds rated below CCC+, but could continue holding bonds that get downgraded below this level. Though this is a radical change in terms of public policy, it will not have much impact on Sissener’s strategy. “We are not specifically seeking to “front run” public sector purchases of corporate bonds, but do want to avoid buying bonds that would be ineligible for those purchases. This tends to rule out smaller and less liquid issues or those from smaller companies. The bond buying program is designed to support vital infrastructure and jobs,” says Sissener.
The Norwegian program is intended to provide liquidity, rather than bailing out companies, while maintaining creditor interests. It will not prevent defaults. Name selection remains paramount for credit investors in this climate, but the public sector support could provide some degree of backstop for liquidity in the market. That could help Sissener to continue its nimble trading if there is another rout.