– We have worked together for many years, and during this time we’ve developed a model that we believe in when it comes to finding- and timing investments in Europe’s most promising and stable small cap companies, says Carsten Dehn. Carsten previously managed SEB’s European small-cap fund for ten years, of which seven years together with Ulrik Ellesgaard. The fund had a five-star rating from Morningstar measured on three, five and ten years. The duo was recognized through several awards, including Best Fund 2014 and Best European Fund 2015 by Fondmarknaden.
– Our view of Lannebo Fonder was that of an independent fund management company with a clear focus, skilled managers and high quality. This was confirmed when we started discussions about joining the team, which was especially inspiring for us given we came from a large bank, says Ulrik Ellesgaard.
Carsten Dehn and Ulrik Ellesgaard have their own screening model to identify promising and stable investments among Europe’s eight thousand small cap companies.
Why is it particularly interesting to invest in European small caps?
–Above all it is because the universe of small companies is much bigger in Europe, where 91 per cent of European listed companies are small caps. However, these 8000 companies only account for 11 per cent of market capitalization. The effect is that small companies are not followed by analysts to the same degree, which means there are opportunities to find gems – companies that are comparatively undervalued and whose value growth we can take part of over a longer period, explains Ulrik.
– But this of course requires a high level of discipline and efficient models to find these companies while also avoiding the landmines, Carsten adds.
How do you choose the companies?
– We have defined some key indicators that we systematically start with in order to sift through Europe’s 8000 small cap companies. Following this initial screening, we continue to sift through the one thousand most liquid companies, and of those companies we do a quality screening based on some additional key ratios. This leaves us with the top, approximately, 250 companies that we will analyse more thoroughly, says Carsten.
–In addition, we always have our eyes and ears open for new ideas. When we meet with company management we always ask about their customers, suppliers and competitors – and this tends to lead to new investment ideas, says Ulrik enthusiastically.
Ulrik Ellesgaard walks through a portfolio company together with Retail Sales Associate, Emelie Wallin.
Focus on quality
–We are looking for reasonably valued quality companies with good management, strong balance sheets and proven good results in both upward moving- and declining markets. Ideally, we want to see that companies are global leaders in their niches. Once we have identified these companies, we always meet with their management and ask detailed questions. This gives us the basis to forecast and evaluate opportunities and risks. The risks, of course, are extremely important, which is about understanding operational risks and external risk factors, as well as valuation risks of the shares themselves. If the outcome of our evaluation leads to a good forecast with manageable risk, and our outlook for the company is more positive than both that of the company’s management and of analysts – then we invest, explains Ulrik.
Carsten provides an example:
– German Stabilus is a global market leader for gas springs and shock absorbers. The products are primarily sold to the automotive and engineering industries. If you have a car with an automatically closing trunk or that has variable position seats, you can expect that the springs are provided by Stabilus. The customer base is diverse, and the company has the advantage of both economies of scale and pricing power, combined with growing demand. We believe that performance will improve significantly and that the market currently undervalues the company’s high-quality.
The portfolio is comprised of about 30 companies, and Carsten describes how they reflect over divestments:
–Our goal is to invest long term, preferably three to five years; but sometimes a company does not develop as expected. If a portfolio company issues a profit warning we quickly form our own opinion. We do not automatically divest a holding – but our experience is that profit warnings usually come in numbers. I would say that we are unusually strict and disciplined – we never stay invested in a company in the hopes it will get better.
Sustainability usually means efficiency
The portfolio managers follow the investments through daily monitoring and official reporting. In addition, they meet company management three times a year. On the topic of sustainability, Ulrik says:
–We always discuss sustainability aspects at company visits. The companies that have environmental issues high on their agendas, have clear guidelines about social aspects and that are strict about the ownership structures as well as incentives, are always the most efficient in terms of earnings. In our opinion, a company’s sustainability aspects cannot be differentiated – they go hand in hand.
Carsten gives an example:
– Just the other week we met with Swedish Thule, which is one of our portfolio companies. Environmentally they are in the forefront, which we feel is necessary for a brand that caters to a clientele interested in the outdoors. Thule showed us how they incorporate environmental awareness in their business, where they proved that their sustainability work is for real – and not just on “PowerPoint”.
Fund start – under a notch
The portfolio managers talk about how excited they were when the new fund Lannebo Europa Småbolag was launched in October 2016:
– Teamwork is effective at Lannebo Fonder and we had a steady flow of capital to invest from enthusiastic customers that gave us their confidence, says
Carsten. Ulrik adds:
– We strive to make long-term investments, and because we take some risks to achieve a high return means that investors should also have a long-term perspective, which was extra important to explain during the fund’s first months.
At year end, just over two months after starting, the fund’s return was below expectations. Carsten explains:
–The fund’s start went less favourably than expected; but there is a clear explanation given the large sector rotations that occurred in the equity markets at the fund’s inception. Cyclical shares – such as engineering companies and commodities – increased, while growth stocks fell, which was contrary to recent years. We have not benefited from this change given we prefer to invest in quality companies with a strong growth profile, as opposed to cyclical companies that depend on external factors such as commodity prices and free trade. Our benchmark index is comprised of a large proportion of cyclical shares and as a result outperformed our fund at the start.
Have seen it before
– It’s painful when markets are against you – but we’ve seen this before. It’s classic that cyclical shares perform better on signs of economic upswing. Over the long term, however, quality companies tend to outperform cyclical ones, which is a philosophy we will always maintain. We look ahead and feel confident over our assessments of our portfolio companies and their prospects, says Carsten, while Ulrik rounds off the interview:
– We also look to find ways to take advantage of the upturn for cyclical shares. One example is our UK holding in Rotork. They are market leaders in the manufacture of actuators and control valve products, with a large exposure to the oil and gas industry. Even with declining oil prices, the company has proven that their business model holds – a great example of a quality company with a cyclical exposure. We also know that Rotork has made important investments that will benefit the company’s efficiency.