MONTHLY LETTER FEBRUARY 2019
Madrague performed well during the month of February: +2.84%.
The equity markets continued the rebound from the lows towards the end of 2018. European banks got a boost from an indication by the ECB that the long term funding help (TLTRO) would be extended in some way or form. We can understand the initial euphoria from the investment community, but can’t help to think that it is a sign of weakness that the sector still needs this kind of support in today’s late stage of the economic cycle. Disregarding property prices in Stockholm and the odd Fintech billionaire roaming the streets there are very few signs of economic expansion that is detectable to the Madrague eye. The prospect of entering the next recession with high leverage, negative interest rates and elevated friction in global trade unfortunately looks both increasingly likely and worrying. The timing of this is not the edge of Madrague and we do not try to time the market for those events. For Madrague it would be an exercise in futility so we leave those investment-propositions to investors with a more top down driven approach. We are reactive to macro events and proactive when it comes to stock picking. This means that we de-risk the portfolio in times of increased volatility and poor performance. That is what we did in the 4th quarter of 2018 and as the market has stabilized we are now back within our normal gross exposure range. In our last monthly letter we commented on a few of the risks to the asset prices going forward. Even though we have a positive bias (normally between 20-60%) we believe that one of our strengths is to manage downside risks. Over time we have captured +50% of the upswings in the market but only participated <25% on the downside. We are agnostic to the absolute level of the stock markets. Our alpha generation has been c60% of our returns over time and has a zero correlation to the European equity markets. Our aim is to manage risk when the markets shift from one level to the next and then continue to generate alpha. It has worked for 17 years and we see no reason why it should not work in the future. Markets change, but both absolute and relative value will be available in the markets for those willing to do the work.
Sectors of note in February:
Biggest contributors were a short position in Swedbank and long positions in ING and Unicredit. Swedbank was hit by accusations of money laundering in the Baltic region. The accusations were published by the Swedish state television and backed by Bill Browder who made the Magnitskiy law come true in the US. Browder has at least a couple of Russian thorns in his side and is not afraid to take on the biggest opponents (book tip is “My War with Putin” by Browder himself). The money laundering in Swedbank so far looks a lot smaller than the scandal surrounding Danske Bank and trying to assess potential damage, litigation and fines is almost impossible. But to motivate the drop in market capitalization we would need a hefty fine from the DoJ. We only covered a small part of our short as we still think Swedbank is too expensive with very little operational upside and regulators breathing down their neck. When the ECB indicated an extension/replacement of the TLTRO program we increased our long position in ING and entered into a long position in Unicredit. Unicredit would be one of the banks to benefit the most from en extension and we believe ING has taken too much of a beating during the last years bear market for European banks. The baby has been thrown out with the bathwater as the Swedish saying goes. In February we also increased our short position in SEB and re-entered a short in SHB.
The sector is one of smallest nowadays after a difficult 2018. Over the last 7 years it is one of our best performing sectors and we continue to allocate the same amount of resources and data-mining in the sector as before with the firm conviction that it is great source of alpha for us in the long run. In February we re-entered 3 semiconductor stocks on the long side as expectations has been too depressed. Microchip, STM and Nordic Semi. The two first names are all a play on an improved environment for the semi industry with destocking and price pressure over the last 6 months. Nordic Semi hit new lows where we think that the struggling on-going low energy business is masking future value in Nordic’s narrowband IoT 5-g chip (built by opportunistically recruited ex Nokia employees in Finland) which is continuing to win design deals. STM and Microchip are a more long term investments where we see considerable upside in the case of an upturn in the business cycle.
Best performing positions were our short in Mediaset, and our long Entertainment One position. We also had a very good performance in our spread between Schibsted A and B shares. The thesis in Schibsted is that the spread should narrow significantly when the company spins out the non-Nordic classified business, Adevinta. The new company will only have one share class which means that c60% of the current market cap of Schibsted will have a spread of zero within a couple of months. This should be reflected in the spread. Mediaset is a highly geared company, 5.8* net debt/EBITDA, with a challenged business model operating in a poor macro environment. We continue to be short. Entertainment One produces films and television shows, but the main value driver is in the family segment where it owns brands with a global reach. The family segment represents 13% of revenue, but 43% of group EBITDA. The aim is to capture more of the value chain in TV and film as well. The company is not priced for success in those segments and we would argue there is a call option in the share price if it were to succeed.
Gross exposure was increased from 139% to 177% in February as the market volatility decreased and performance improved. We also increased our net exposure from 34% to 39%. 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.
Chief Investment Officer