pareto

Nordic Alpha Long/Short Nordic equities

Christian T. Nygaard christian.nygaard@paretoam.com

November 2015

Disclaimer | 2

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Variable net bias Long/Short Equity funds  Nordic Alpha - $ 150m – Sep 2003 – UCITS version 60m – Offshore 90m  Nordic Omega - $ 30m – Dec 2005 – Only offshore – Same investment approach as Nordic Alpha, but focus on small-caps

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The Nordic economies  Population 27m  GDP $ 1700bn (43k p.c., all above Germany and the UK)  High level of education and R&D  Strong fiscal balances

 Good demographics  Flexible labour markets  Open economies = continuous competitive pressures

 Total market cap $ 1600bn  Highest density of top-return on capital companies

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From $100 to 25,000 in 45 years

Pareto Nordic Alpha | 6

Fund manager Christian T. Nygaard 

Co-managed Nordic Alpha from 2003, head manager from October 2008

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Investment manager with Aker from 2000 to 2002

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Head of Research and analyst at Carnegie and Enskilda in Norway and Alfred Berg in Russia between 1994 and 2000

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CFA (NHH), M.Sc. Finance (NHH, Universidad de Barcelona)

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Degrees in Russian (Jr. Lieutenant Armed Forces) and Spanish

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Award nominations

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Performance Since change of head manager

Sources: Bloomberg, Pareto Asset Management. Nordic Alpha plc and Nordic Omega plc NAV as of end-October 2015.

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CAGR Annualised volatility of 11%, average net exposure 70%

Sources: Bloomberg, Pareto Asset Management. Nordic Alpha plc and Nordic Omega plc NAV as of end-October 2015.

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Average annual alpha = net return - (net exposure x index return)

Sources: Bloomberg, Pareto Asset Management. Nordic Alpha plc and Nordic Omega plc NAV as of end-October 2015.

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Exposure Moderately positive net exposure 90%

80%

70%

60% Long

Short

Net

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Exposure by theme

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Exposure by country

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Investment Style  Deep in-house company analysis, focus on stock selection  Aligning bottom-up stock selection with top-down market direction view  Low turnover (0.5/y)  High concentration (appr. 25 positions)

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Stock selection – Quality Superior position, growth and capital return at reasonable price

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Stock selection – Quality Median characteristics for our companies

 Market position – #1 (all companies)  Market share – 31% (#2 player 19%)

 Organic growth Q3 – 9%  ROCE 2015 – 17%  EV/EBIT 2015 – 13.5 (discount to Nordic market at 14.8)  Three biggest position owned on average for 7 years with return CAGR of 29%

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Stock selection – Quality Case – Autoliv – leader in car safety

 38% market share in passive safety (air bags, seat belts)  25% market share in active safety (cameras, radars)  8% organic growth in Q3 vs global car volumes flat  26% ROCE (16e), 41% pre-r&d

 EV/EBIT (16e) 11  Total return over 4 years at 209% (CAGR 33%)  1.3m people die in traffic every year

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Stock selection – Valuation Mean-reverting valuation ď ˝ Opportunities arise with degree of popularity and external shocks

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Stock selection – Valuation Cases  Short company in the leisure industry – ROE of 10% (0-15% last 20y) – Peak Price/Book multiple of 2.6 – Net debt/EBITDA 4x – Negative acc. free cash flow last 10 years – Negative return so far

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Stock selection – Valuation Cases  Stora Enso – Mr. Market: «A doomed paper company» – No! Paper is 20% of CE with 10% ROCE – Great capital allocation to high-returning pulp and packaging – 20% of EV in forests – Total return over 3 years at 93% (CAGR 25%)

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Stock selection – Valuation Cases  Telenor – Bought when company was penalized by unpopular India venture

– Total return over 7 years at 320% (CAGR 23%)

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Stock selection – Cyclicality Mean-reverting profitability of cyclical companies  Companies tend to expand in good times and vice versa, collectively creating boom and bust cycles  Median for the companies we own – ROE ¼ and Price/Book ½ of peak last 15 years

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Stock selection – Cyclicality Case – Electrolux – 10 years of headwinds from costs and volume  Sales flat for 10 years  EBIT margin from 3 to 4% – Including 1pp average margin headwind per year from higher steel and plastics costs – And 1pp per year in costs for closing factories  Headwind is about to turn to tailwind  White goods volumes in Europe (1/3 of sales) flat since 2005  EV/EBIT (16e) at 20% discount to market

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Net exposure management Bottom-up meets top-down  Anemic demand growth – No pull from China – Cheap money impact on demand in OECD largely behind us – Fiscal policy tool box is empty  Cost of capital will stay lower for longer – Inflation is dead – Central banks stay soft to stimulate demand  Both support the case for our Quality theme (2/3 of our net long)

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China Investment growth going down, consumption may hold up  The one-child policy boosted savings, will reverse  But capital deepening has long way to go  And the government will attempt to bridge the gap

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Central banks to stay soft Demand growth and asset appreciation at future expense

290% 8%

280%

7% 270% 6% 260%

5%

250%

4% 3%

240%

2% 230%

1%

220%

0% End 2000

Source: McKinsey

End 2007

Mid 2014

CAGR 00-07 Credit growth

CAGR07-14 GDP (nom)

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The cost of capital will stay low  More flexible labour market  High unemployment

 Better price transparency for consumers  New capital-efficient business models  Sharing (cars in use 5% of time)  Higher asset turnover  Need to keep credit growth going  Saving the EMU

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Net exposure management Valuation  Macro and earnings estimates equal current conditions, so they are in aggregate useless – and subject to large revisions  Consequently, aggregate P/E and EV/EBIT are useless

 Price/Book measures the value of the production and earnings capacity

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P/B vs next year’s return at Oslo Børs

Returns based on Total Share Index/Oslo Børs Benchmark Index. Source: SEB, Pareto Nordic Investments, Oslo Børs, Bloomberg

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APPENDIX

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The manufacturing cycle is stabilising

Source: IMF, National Sources, Goldman Sachs Global Investment Research

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US PMI to rebound Inventories peaking

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Consumption in Europe is a bright spot High private savings and increasing income

Source: ECB, Goldman Sachs Global Investment Research

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Interest rates vs company cash flows More upside for Nordic equities

3,2%

Source: SEB Enskilda, data excl. financials 20.10.2015

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Valuation USA on the high side because of low rates and labour compensation

Source: Swedbank

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Flow of funds supportive USA - preference for fixed income will change

Source: ABGSC

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Other positive factors  Consumer surplus not in GDP – What would you pay for this?

 Energy will still get cheaper  More efficient logistics and capital employed – Corporate margins at an all-time high, but asset turn grows 2.5% annually – Three years of asset turn growth neutralises 1pp margin decline

Source: ABGSC

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The Nordic economies – rich, competitive and international

Source: The Economist; IMF; World Economic Forum; Economist Intelligence Unit; World Database of Happiness, Goldman Sachs Research estimates (GS SUSTAIN)

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The Nordic economies – high asset turnover and capital return

Source: Goldman Sachs Research estimates, DataStream

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Exposure Nordic Alpha plc 140% 120% 100% 80% 60% 40% 20% 0% 31-Oct-08

31-Oct-09

31-Oct-10 Long

31-Oct-11 Short

31-Oct-12 Gross

31-Oct-13

Net

31-Oct-14

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The short side Regardless of market view  Selective stock selection across all three vectors  Pair trades

Possible hedging with current positive market view

 EMU break-up – Telecom and utilities in countries with weak current account and debt position  Monetary policy impact breaks down – But long in companies with credible organic growth, construction, gold miners  China’s investment boom is mature – Commodities and capital goods When negative market view  High beta (materials, capital goods, consumer discretionary)

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Net exposure management Be fully invested most of the time ď ˝ The economy and equity market grow together ď ˝ Utilize extreme shifts in earnings

USA CAGR 6.5%

S&P 500, Logarithmic scale. Source: Bloomberg.

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Net exposure management Aggregate earnings estimates are useless ď ˝ Short-term share prices run ahead of estimate changes ď ˝ Historical earnings drive earnings estimates

S&P 500 12 months trailing 12 months forward

80% 60% 40% 20% 0% -20% -40% 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 EPS (T12M)

February 2015. Source: Bloomberg

BEST_EPS (F12M)

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Net exposure management Bet on industrial production cycles  Cycles tend to last for 8-10 years  IP is about 1/5 of global GDP and a volatile component  Correlates well with Norwegian equities

Source: Swedbank; EcoWin, First Securities