MONTHLY LETTER DECEMBER 2018

December comment

Madrague had a very tough month in December: -3.5% which takes the yearly figure to -8.82%.

Our performance is very disappointing both in December and for the year as a whole. Our hallmark since inception has always been to preserve capital, protect down side and deploy capital when our trading theses are in sync with the market. It all sounds simple and we have always felt that it is an easy strategy to explain, but hard to replicate as you need a mix of characteristics in a team to be able to scale the strategy and perform over the cycles. With a 16 year period of refining the strategy we are of the opinion that we have gotten to the point where scale is definitely achievable. As with all industries we need to be humble when we are successful, disciplined when we go through tough times and open-minded when looking at new opportunities. In the last 2 years we have been through all the emotions: in January 2017 we picked up the Eurohedge award for best European hedge fund in 2016. Now in January 2019 we are sitting with our worst year ever behind us. It is not a case of having lost our humility, discipline or curiosity. What we have done though is make a string of bad decisions on the back of rational arguments going through the same vetting process as the previous 15 years. We are deeply disappointed with our year. Our first, second and third priority are to our investors. This means that at all times the drive to find new ideas and evaluate existing positions is first priority. We partners have all our excess net worth invested in our fund which means that our interests are totally aligned with our investors.

The equity markets experienced both a loss of faith in the economic cycle and early signs of doubts in the credit cycle in the fourth quarter. S&P 500, which tends to be a beacon of stability when global equity markets starts to tremble lost 14% in the quarter and the 30 days realized volatility in December went from 6 to almost 30: equivalent of below 0.5% daily move to almost 2% daily swings. This all happened, to our mind with very few major surprises. Trade war, brexit negotiations, Italian budget were all known un-knowns at least since a couple of months. What did change though in December was an expectation from the market that the FED would lower the future rate path. When Chairman Powell sounded less dovish than the market had hoped for we got an extra push lower. The equity markets were a tad disappointed, to say the least, which is understandable as the interest rate market at the end of December were pricing in a 75% chance the FED would stay on hold in 2019. This was up from 25% at the beginning of month. The possibility of a FED policy mistake scares both the market and Madrague. We do not believe this will happen. The FED has manoeuvred the last decades very well. Not that we agree with all their decisions, but their data dependency and their interpretation of the data has so far proven to be very good for asset pricing. The big question is rather if we are coming to the end of a very long credit cycle and debt expansion. The cocktail of potentially less liquidity, higher rates, low inflation, lower growth, higher cost of credit coupled with increased trade friction (Ricardian growth reversing) could prove to be very nasty. We do not believe this is the time for that, but do acknowledge the risks have increased.

Sectors of note in December:

Business Service: +0.2%

Long positions in Jackpotjoy and Nobina coupled with short positions in Marine Harvest (change of name to Mowi after year end), Bakkafrost and Kindred were the biggest contributors. Nobina, Nordic public transport, reported very solid q3 figures in December. The company trades on c6% dividend yield with government backed contracts and cost base closely linked to CPI. The company should be very resilient to all the macro issues discussed above. Marine Harvest and Bakkafrost in the salmon sector have benefitted from a hype in the investment community where the equity market is confusing healthy food with buying opportunities in the stock market. The underlying salmon price was very volatile in 2018, but ended the year more or less where it started the year. Bakkafrost and Marine Harvest were up 25% and 42% respectively. So we have companies with all the characteristics of being a commodity play (volatile price of commodity, fixed cost base, FX dependent) being re-priced in line with sectors with much more stable business models. The mentioned companies were all in the fund at the end of the month.

Telecom: -0.7%

We wrote about the Telecom sector in our last monthly note so we keep this comment a bit shorter. December proved to be a complete reversal of the good November performance. Long positions in Veon and Hellenic Telecom were the source of negative performance. We kept both Veon and Hellenic in the fund, but decreased the net exposure through selling Telefonica and Telia.

Retail: -0.6%

Long positions in Anheuser-Busch (ABI), Oriflame and Associated British Food (ABF) were the main detractors in an absolute sense. The biggest reason for the negative performance was our shorts that did not go down with the market or the sector. Clas Ohlson came out with numbers and a strategic overhaul where the company announced an exit from UK and Germany. The market liked the news and sent the stock higher. Our shorts in Axfood and Royal Unibrew were down on the month, but not enough to cover the losses from our long positions. We closed our positions in Clas Ohlson, ABI and ABF in December. Gross exposure was decreased from 138% to 110% in December as the market volatility increased dramatically coupled with poor performance. We also reduced net exposure from 43% to 26%. Our option protection shows the same characteristics as always, i.e. a gap move down 5-10% and we would have zero net exposure to the equity markets.

As always, you are more than welcome to contact us should you have any comments or questions on our investments or the views expressed in this letter.

Lars Frånstedt
Chief Investment Officer

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