Getting defensive

This post is inspired by a question from a friend of how I like to play defense with my investments. 2018 has so far felt like treading water investing wise. Working pretty hard, not too much to show for it. That is the feeling. Numbers wise my account is up ~12% will SIXRX is down 2-3%, so I shouldn’t complain. My stockpicking has been a bit more spotty in the past with some decent successes in e.g. Xintela, Irisity, Smart Eye, KV77, Rottneros to name a few. However my largest weighted picks, Storytel and Xbrane have had a tough year. A lot of learning from those that I’ll try to write about in a future post. Here we’ll dwell on the macro outlook and how I’ve tried to adapt the portfolio the match the environment as it develops.

So the big picture is that central banks are, starting in the US, becoming less accomodative. This is expected to continue in Europe. Historically this has been tied, with some lag, to less favorable equity markets. The rising interest rate has, through the discounting mechanism, a stronger effect on the cash flow streams with a rising future payment. Such as growth stocks. Liquid assets are hurt less. Perpetuities such as preferred shares are hurt less since current payments are high. They will, all else equal decline, in both real and nominal terms with a rising interest rate. Inflation hedged cash flow streams, such as e.g. a tobacco company with pricing power (Swedish Match) will be able to increase their prices and have a stable demand outlook even in tough times. For this reason their cash flow stream can be expected to stay constant in real terms (rather than the nominal constancy of preferred shares). The cash flows will however be discounted more than at a lower interest rate. If they are also loaded with debt, such as SM, those payments will increase as well. So they are defensive, but only in relative terms.

Less coupled to interest rates are cash and commodities that always have utility value in the present moment (not counting commodity stocks here). In relative terms this will also apply to stocks holding such assets.

Currency-wise, the USD has been linked to relative outperformance in risk-off environments. There are arguments for a weaker dollar over the long term. I feel this will be overshadowed by the value of the reserve currency status, which is still mostly in place, during the coming 2-3 years. If this turns out to be the case exporters with costs in weaker currencies and incomes in dollars will have a slight cushion against the discounting of future cash flows in the form of increased growth at least over the medium term.

The opposite of being liquid is to need an influx of capital. Capital will become more costly to tie up than what the last decade has taught us, and cash drainers will likely see dilution at a level higher than they planned for before reaching profitability.

So to summarise, stock-picking should place an increased emphasis on:

1) Low capital needs

2) Exporters, primarily pricing in USD

3) Net cash rather than debt

4) Current profitability and profit levels

5) Demand resistant to recessions

If I match this to some stocks I like I see that MIPS checks 1,2,3, half of 4 and 5. It has also become expensive, so I have still sold most of my position.

Storytel has 1) thanks to funding themselves in the middle of the summer. They also have 5). Weaker on 2,3,4. Still, valuation has already come down and I see no reason to sell heavily now. Execution from the company and traction in the market seem stable to good.

Mekonomen has, after their purchase, 1,4 and 5.

SAAB are currently taking on more capital. Apart from that, they have 2, half of 4 and all of 5.

Forestry, e.g. Latvian forest, have 1-4) down pat. 5 is debatable, but current profits will not drive valuations as much as NAV. I have increased my holdings in Latvian during the autumn.

Gambling stocks, especially a service provider such as Evolution Gaming, has many of the qualities seen in 1-5. I have a minute position, but will evaluate it further inspired by writing this. I have an emotional problem with many gambling stocks, but Evolution are at least providing work for many young people and providing some form of real social interaction.

Banks have stable demand and high current profitability. Some prospects of raising interest margin with higher rates. Insurance companies have the same picture on the demand and profitability side. Interest income can increase with higher rates. Effect on profitability of claims inflation can usually be handled by price indexing. Here my main pick is Storebrand which in addition has a fairly sizable life portfolio where the liabilities will decrease in relative terms with an increasing interest rate. Sampo is also interesting and I have a small position. They are a counter-cyclical player that is currently well capitalised, e.g. high points on 3) above, as well as 1,4 and 5). The only fear is how declining new car sales and possibly an aging car fleet in case of a recession will hold back premium growth. On relative terms to other P&C insurers in the nordics recent results have been outstanding.

What to sell?

Growth plays of all kinds, especially those where unsure of eventual success or possible capital needs. List to come, but some obvious candidates are:

ClimeOn,Veoneer,Immunovia (I like the co..),Hövding (I like this co though..), BIMObject (demand in construction a headwind?),Optifreeze, Alzecure after IPO, Risk Intelligence. Feel a resistant to do this, but I think I will force myself to do it, and do it on a market up day since we seem to have a daily sigsaw going lately.

Apart from stocks and cash I have about 1% invested in put options for end of 2019, 15% below current level of OMX index. Also 5% in USD cash, 3% in gold and a few % in commodities. Now what remains is to be patient till it gets really cheap sometimes in the next few years, and not get left behind waiting for a bottom that never comes. I expect some leveraged players to have a thin sliver of equity when it turns, and have a quick ride up. Hope to take advantage of that when the time comes.

Results and thoughts of 2017

Time for the yearly summary. There might not be much content here, but in investments consistency is key. Therefore this habit will be kept alive.

Results this year was +38% in SEK. Add 2-3% for cryptocurrency gains on the side. The SIXPRX which is the main benchmark was up 9%.

 

Process Successes

– trying to participate in inefficient markets: This has been a hallmark since starting to invest in illiquid micro caps. Continued this year with Cryptocurrencies. There is clearly more irrationality and tradeable patterns in this type of space.

– Hedging. I lowered the risk a lot and made some money by hedging. I.e. selling short Electrolux, Tesla, Snap. Also Vestas but there I didn’t have conviction to hold and exited +- 0 after which the downward trend began promptly. Also adding to a select few yield type instruments I believe decreased risk, although at a pretty big opportunity cost. Still I think it’s worth it for peace of mind.

– allocating on a % range to asset classes. I knew this from reading, but knowing the emotional side happened this year with Bitcoin. Before deciding on this strategy I sold of a quite large position after a +50% gain and only kept 10% of said position. If I had used the %range strategy to this of 2-4% allocation to cryptocurrencies that I later adopted it would have added something like 10% to the return figure.

 

Process Mistakes

– too slow/weak rebalancing of positions. I want to train myself to sell aggressively when conditions warrant it, although if it means not being able to execute at quite the current price. I.e. after house-rally in Stillfront, XBrane get overstretched. It is of course never totally apparent that it’s overstretched but you can get an indication thinking about: What more does the company have capacity to deliver after this? Is the pace of positive news likely to increase or decrease? How big part is positive now? The other side of the coin is to allocate at scale to obviously cheap positions. I think I’m slightly better at this, but also feel like it could be improved and has become a bit too cautious because of the increased size of the portfolio.

– too much focus on IPOs. They have definitely added to returns, but probably not commensurate to the amount spent. The strategy of selling after 3 days on a positive opening seems to work decently well. Unless it is up +80% when profit is taken immidiately. Sell out slightly negative openings right away.

– hedging with weak conviction. I feel like options work better than the. miniskirt/minilongs which I don’t truly understand how they work. Options are expensive to trade but my results have been much better. Will see if someone offers more options than Avanza / Nordnet for shorting i.e. Tesla.

Learning

– Had time for two physical presentations this year – XBrane and DDM. Will try for a few next year as well. It can add or detract from conviction in a good way. I think in XBranes case it on the balance added to conviction while DDM was neutral/slightly negative (update Nov 2018: being to this presentation made it easier to sell this after mgmt changes, which turned out being a good move).

Portfolio update

  • Largest positions: DDM, Ferronordic Machines. XBrane, Storebrand, Catena Media, Stillfront, Storytel.