The Interview – Nicolai Borcher Hansen, Aros Capital Partners: “Risk aversion in the market is back to August 2007 levels”
Aros Capital Partners has just launched its first investment vehicle, the long-biased global macro Aros Paradigm Fund, with friends and family capital. Chief investment officer and founding partner Nicolai Borcher Hansen (pictured) says the fund’s investment strategy will target value-based investment in equities and corporate bonds as well as exploiting the firm’s expertise in the niche area of Danish mortgage bonds.
GFM: What is the background to your company and fund?
NBH: The Aros Paradigm Fund, which follows a long-biased global macro strategy, was launched on November 2. The managers are Peter Brink Madsen and myself, who have worked together for around six years, and the investment team also includes Anders Lund Larsen. The fund is a Sicav structure domiciled in Malta.
GFM: Who are your key service providers?
NBH: Our auditor is Ernst & Young and our law firm is Eversheds. The fund’s administrator is Citco Fund Services and the prime broker is UBS.
GFM: How and where do you distribute the funds?
NBH: Due to a legacy client base, Denmark will be one of the primary initial targets. However, the fund will be distributed on a global basis focusing on Europe, although it does have a US dollar share class for US tax-exempt investors and will start distribution there in the first quarter of 2010.
GFM: What is your investment process?
NBH: The investment strategy is based on modern portfolio theory, utilising a proprietary optimisation model with the aim of achieving the optimal risk-return ratio. The inputs to the model are standard deviations, expected returns and correlations of the underlying investments based on the fundamental analysis of the investment manager as well as quantitative analysis of asset and liability correlations.
The master fund may utilise up to two times leverage within the investment limits of the investment mandate (implying a minimum fund solvency of 33.3 per cent), with the aim of achieving the optimal asset and liability allocation. Leverage may take the form of trading on margin, investing in derivative instruments that are inherently leveraged, and entering into other forms of direct or indirect borrowing.
The portfolio composition of asset and liability classes is the result of the investment manager’s aim to maximise the risk-return (Sharpe ratio) potential of the portfolio. The investment manager’s view on the model inputs is based upon assessment of the overall macroeconomic environment and the premise of mean reversion over time on most risk and return factors. The view is that returns, standard deviations and correlations are non-static and will over time revert to the long run mean.
GFM: How do you generate ideas for your funds?
NBH: Aros has a fundamental, value-biased investment approach to stock-picking. The focus is on companies where the investment manager sees under-appreciated cash flow generation, liquidation value in excess of the present market value, long-tailed order flow not reflected in the market value, and the potential for increase in the dividend and/or a stock buy-back, as well as companies with improving earnings generation either due to a long-term trend not reflected in the present valuation, or that lack analyst or investor coverage and attention. Short selling may also be applied at sub-index level to capitalise on stock-specific exposure.
With respect to corporate bonds Aros has an approach that is similar to its approach on equities, and the same factors apply as to stock selection. For the investment manager, the choice of investing in the equity or debt of a company is purely a question of relative value on a risk-adjusted basis, given the portfolio’s asset allocation restrictions.
Investment in mortgage bonds will mainly be undertaken in Danish instruments, where the investment manager has significant experience in a niche market with superior risk-adjusted opportunities.
GFM: What is your approach to managing risk?
NBH: The capital is allocated according to our dynamic asset allocation approach, where we constantly aim to create the portfolio with the highest risk-adjusted return. As such, we can stress-test the investment allocation before it is invested in the market using traditional empirical value at risk and conditional VaR (tail risk). Risk management is a natural part of the ex ante investment decision.
GFM: What opportunities are you looking at right now?
NBH: We are looking at investment-grade corporate credit, high-yielding equities and Danish mortgage bonds, market segments that still show attractive risk-adjusted opportunities. However, we are very conservative since risk aversion in the market is back to August 2007 levels. Our view is that a significant part of the repricing is fair but that we will still see uncertainties in the next 12 months.
GFM: What developments do you anticipate in your sector in the year ahead?
NBH: We expect to see continuing normalisation of the various markets, including short-term interest rates. At some point central banks’ rhetoric will tilt toward a hike in the interest rates; this signalling can affect liquidity and bring volatility back to the market. We will continue to have a conservative approach and conserve opportunities to react on a contrarian basis when opportunities arise in asset and liability classes carrying risk.
GFM: Are investors’ expectations shifting between capital preservation and growth? If so, how do you deal with this?
NBH: As a long-biased global macro fund, the Paradigm Fund will carry a risk component. Capital preservation is part of the investment strategy, but at the same time we acknowledge that over time the investor is compensated for taking a certain degree of risk.
GFM: What differentiates you from other managers in your sector?
NBH: We systematically exploit long-term mean reversion in different risk premiums instead of focusing on short-term movements. Working across different asset classes allows Aros to exploit mispricings across different markets, that is, inconsistencies in the valuation of debt and equity of the same company.
We employ a holistic optimisation approach, incorporating both assets and liabilities instead of optimisation within single asset classes that may result in overall sub-optimisation. The strong focus on the dynamics of the correlation structure between asset classes differ from the conventional approach.
We provide security selection skills combined with asset allocation expertise in a single product. Though the asset-liability allocation process is supported by a very thorough quantitative analysis, decision-making is based on the investment manager’s subjective judgement and therefore the process is by no means a purely quantitative approach.
GFM: How do you find the environment for fundraising?
NBH: The market for fundraising is improving, but is still challenging. Our experience is that the institutional segment is showing significant interest but at the same time is hesitant to commit to a pre-launch fund. As a result, we have launched with backing from the closest of our friends and family with the aim of then gathering assets post-launch.
GFM: Are you planning any mergers or acquisitions?
NBH: At the moment we have the right size with people in total including sales and advisory staff, fund managers, analysts and administration. We have from day one built an institutional infrastructure with leading vendors and advisors, and with this set-up we are planning to take on board other fund management teams as a sort of joint venture. We will supply the infrastructure and administration platform, while they will do what they are best at, fund management.
GFM: Do you have any plans for other product launches in the near future?
NBH:In the first quarter of the new year we plan to launch a fund committed to making social impact investments in companies on commercial terms.
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