Madrague had a decent month in September: +1.62%. The month was again dominated by the debate on cyclical vs. defensive companies. We have written about the issue in previous letters and expressed our view that the valuation discrepancy is too big. At the start of September, the equity market took a massive turn in our direction. It did however only prove to be a short flash in the pan and towards the end of the month almost the entire effect had been erased. There are clearly big forces at play when we see these violent swings in such short time periods. We believe there are two events that can reverse the hunt for yield: a trade agreement between China and the US and/or increased interest rates and growth. Both issues are of course clearly interlinked, and any agreement reached won’t bring us back to pre-war status. However, that is not necessary. All that is needed are rules that the market and companies believe are stable and reliable. It certainly doesn’t sound like too much to ask, but in the current environment we are prepared to accept anything apart from the current limbo.

Sectors of note in September:

Financials: +0.6%

Main contributors were the long positions in Swedbank and Caixabank. Our investment case in the two banks are very different and we come from different angles as well. We were long Caixabank at the start of 2019 and were stopped out when communication from Caixa completely wrong footed us and the market. The bank frontloaded costs and back loaded benefits which scared investors and caused a 15% drop in the share price. We have been monitoring the bank as it is one of the Spanish banks we normally meet at least once a year. We think the bank is well managed but operating in a very difficult economic environment. If the first rate-hike from the ECB is in 5 years’ time (which was implied by the rate market 1 month ago) then all Eurozone banks and banks in other currencies tied to the EUR are in for a couple of tough years. At the beginning of October Caixabank was trading at 0.6 times tangible book for a Return on Tangible book of 10.7% which means less than 6 times earnings. Even in a difficult environment we are of the opinion that there is a price for everything. Caixabank is frankly too cheap. In Swedbank we were short during the first quarter of 2019 with the main argument being margin pressure on mortgages and a valuation which left very little margin for any kind of trouble in the Swedish economy. When the AML issue hit the bank, we got a bit lucky and covered the short towards the end of March. Now the implied hit from a regulatory fine is exaggerated and risk reward is clearly on the upside. It is one of our biggest long positions in the portfolio. We have moved our shorts to other Swedish banks, SEB and SHB.

Capital Goods: +0.4%

Biggest contributors were our long positions in Cargotec and Sandvik. As our Capital Goods portfolio had very little net exposure, we also had good alpha contribution from our shorts in Atlas Copco and Hexpol that were only marginally up in a generally positive equity market. Our Capital Goods portfolio is skewed to long value and short defensive/stable companies. Given the extreme move against value companies after the collapse in bonds in August it might look as an absolute certainty that we would see a partial reversal of that move. Well it is easy to say, but incredibly hard to time those types of reversals. As Keynes said: ”The market can stay irrational longer than you can stay solvent.” Cargotec was up 22% in 10 trading days without any significant news. To our mind this is a testament to the extreme positioning and the result was a whiplash back for the equity price. Sandvik is another example of the same phenomenon: +16% in 10 days with no real news. We adjusted the size of our positions in the companies mentioned above only marginally during the wild swings in September.

Business Service: +0.4%

Biggest contributors were our long positions in Gamesys (previously named Jackpotjoy) and Nobina. Alpha wise our short positions in Intertek and Mowi also contributed with very small positive performance. We have been invested in Gamesys since the spring of 2017. The company is very different to other gambling companies were the average ticket is very small, the vintages of new players tend to stay longer than for other gambling companies and the main purpose of gambling is for leisure and fun rather than getting rich. This might seem odd to most of us who are active in the financial markets. We strive to improve, get bigger, get better and more efficient all the times. Gamesys is almost like an amusement park online. You enter the park, pay for the rides and you exit the park only marginally poorer, but hopefully you’ve had some fun for the money spent. Nobina is a company we believe still has the wrong price given the stability of cash flow and how the company has managed contracts since the IPO 4 years ago.

Telecom: -0.3%

Biggest negative contributors were our long position in Veon and our short position in Tele2. We have been struggling with Veon for many years and continue to view the company as a mispriced asset. We acknowledge that Veon deserves a Russian discount and it has a sprawling number of telecom assets in various parts of the world which is hard to analyse. On top of that you have had two major owners who have had trouble communicating. Telenor now only have c8% left so the ownership should be a non-issue going forward. Veon has simplified the business structure so that part of the discount should be dissipating. We are then left with a Russian discount which should not be enough to keep the company at this low valuation.

We increased our gross exposure marginally from 150% to 152% in August. We decreased our net exposure marginally from c40% 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.

Lars Frånstedt

Chief Investment Officer