Self-management, wholeness at work, and evolutionary purpose

At HCP, everyone gets to choose where and when they work. Our CXM Miika Koskela likes to work remotely not only from his home but wherever he is.

Last year, our fund manager Pasi Havia came across a book called Reinventing Organizations by Frederic Laloux. This book introduces a new paradigm of organisational structure: Teal organisation model. Teal organisation is characterised by three breakthroughs: self-managementwholeness at work, and evolutionary purpose.

This looks a lot like us, Pasi thought to himself and suggested our CEO, Tommi Kemppainen, to have a look. He, in turn, recommended everyone else to read it. And here’s what we think about it.

It is only natural that our own digital nomad Pasi was the one who came across with Teal. He has a background working in the creative IT business. Pasi has always taken his work with him wherever he chooses to live in.

For Pasi self-management is self-evident: “If you are digging a ditch for work, keeping track of the time spent working makes sense. In IT it is different. A lousy line of code does not get any better by punching more hours to the timecard. “

Knowledge work is independent of time and place. We appreciate individual styles of working and offer our colleagues the freedom, responsibility, and support they need in order to bloom.

All working at HCP have diverse backgrounds and skills with different responsibilities allocated. We do not prejudge how others fulfill their tasks – the key is to complete them. When people feel involved, they pursue their tasks in the best way they see fit. This removes the need for micromanaging.

Instead of a rigid hierarchy, the individual with the most expertise works on any given topic and makes decisions after seeking advice from his colleagues.

At HCP, the CEO is one of the team members. One of his tasks is to listen to all others to find out where they are coming from and where they are headed to next. This helps us refine our strategy together accordingly.

Our Compliance Officer Juhani Halminen pointed out one potentially major weakness in Teal: the model has not lived through many economic cycles yet.

To tackle some foreseeable problems, we have agreed on swift decision-making processes during economic downturns. This should allow us to get back to normal Teal-style working even in the worst times. We have also prepared for challenges by saving up a healthy recession buffer for bad times.

An organisation without power hierarchies works for us. In a country with an excellent education system, advanced information networks and a high level of trust among the population, we believe that many other organisations could adopt similar principles. It might seem like many organisations doing knowledge work function without traditional leadership. This, however, is not to say that their processes would not have an appropriate organic structure.

Our first ever company community meeting

“Everyone shades on!”

Limited liability companies are sophisticated platforms for different people and resources to work together for a shared goal. They have their roots for soon 700 years.
 
In addition to general meetings for shareholders (yhtiökokous) there is a need to also meet with all the people we work alongside. Therefore, last Thursday 6th of June we organised our first ever “company community meeting” (or yhtiön yhteisökokous) to meet with all stakeholder groups as they are all important as are the shareholders!
 
This is us. Our identity is shaped by our clients, collaborators, and friends – past, present, and future. Huge thank you to all of you who made it!
 
This is #HCPSPIRIT
 
No one knows how a meeting like this should be structured. What we know is that it must have of all the stakeholder groups and it can not be a closed meeting between top executives and shareholders.
 
“We encourage all companies to find the courage to organize their first company community meeting that has people from all stakeholder groups!”
– CEO Tommi Kemppainen
 

#HCPSPIRIT artist Kuuhullu performs unplugged

CEO Tommi Kemppainen welcomes all HCP community members to his home

Campfire after the sunset

HCP Quant 5/2019 -11.59% | The Work of a Portfolio Manager

In May, markets took a real nosedive with the trade war accelerating. The negotiations between the USA and China have been difficult. Especially Trump’s way to “negotiate” has recently led to a situation which has been humiliating for the Chinese. Possibly the worst thing to experience in this culture is to lose face. This Trump seems to not understand. The negotiations have drifted into a stalemate, which was reflected in stocks all over the world during the month.

The HCP Quant fund decreased in May by 11.59%. During the month, the fund’s US weighting fell to zero. Asia’s weighting is over half, concentrated in Chinese stocks. With uncertainty running high, valuations are low and therefore it is quite natural that many Chinese companies have found their way into HCP Quant. This is one of the reasons why value investing has worked in the long run. When the situation looks bad, a value investor finds more to buy but for the very same reason buying is psychologically difficult. Because the situation looks bad. For the same reason, value investing does not fit everybody. A traditional value investor finds value where many others do not. A value investor goes against the tide: he is a contrarian. Psychologically this is difficult because people are herd animals by nature. It is easier and more acceptable socially to act like the majority of other people. Being wrong in a group is not as difficult as being wrong by yourself with a differing view. In the end, a value investor has to trust that he will be compensated when the situation changes. When the very bad changes into a notch better, i.e. just bad. Then the pessimistically done pricing proves to be overly pessimistic and the undervaluation is unraveled in the form of stock-price appreciation. Sometimes the change of balance occurs quicker and more strongly, sometimes slower and more weakly.

The fund’s benchmark index MSCI ACWI SMID Value Total Return dropped by 6.13% in euros in May. It’s worth keeping in mind that the index has a substantial USA weighting, so it largely follows American markets’ movements. The S&P 500 Total Return index in turn fell by 5.89% in euros and the S&P Europe 350 Total Return by 4.66%. China’s Shenzhen Stock Exchange Small & Medium Enterprises index came down in euros by 11.22% which shows well how challenging the month was to Chinese small and mid-cap stocks.


Every now and then I’m asked what a portfolio manager’s job is like. The work seems to have some secrecy and mystery associated with it. Somehow, this makes me think of the times when I was getting started in investing. My idea of an investor back then was the stereotypical rich, elderly, and overweight man in a pinstripe suit and smoking a cigar. This idea faded away with time as I learned what a typical investor really is like. An ordinary investor is difficult to recognize in the street. He is like any of us. Similar idea are associated with portfolio managers and portfolio management as a job. I believe portfolio management as work is more ordinary than many think. Very far from Wall Street movies’ glamour and excitement, especially in a country the size of Finland.

Of course there all kinds of portfolio managers and employers. The job description and the tasks can vary significantly. It is impossible to answer the question of what one’s typical workday is like, because every day is different. To me, that is the spice of this industry. No single day is the copy of another. If there is something in common between different workdays, it is that one can pace one’s activities and tasks quite freely. On one day, the calendar is full of client meetings, on an other day time is taken up by a report on financial transaction tax sent to France (ahem, like yesterday) and on a third day time is used to log the fund’s transactions into the background system. Especially in a company the size of HCP, the diversity of required tasks stands out. Based on these, I got the idea to log my main activities over a day. This is an overview of my day. It is unlike prior days, and it will not repeat itself. Another portfolio manager’s day would look different. For those interested, however, it gives a good taste of what kind of tasks I performed over one working day.

Tuesday 21.5.2019

9-10
Open the computer, a cup of coffee, and a breakfast sandwich. Researching and reading about what has gone on in Asia and Australia over the night. There are incoming messages HCP’s WhatsApp group about an event being organized in a few weeks’ time. All those invited have not received the message, and a colleague asks for help in finding the right phone numbers, etc.

10-11
The previous day, I’ve been reading the personnel fund law to explore establishing one for the company’s personnel. The CEO sends me a message and asks clarifying questions about my previous day’s message. I immerse myself in the law and find him the answer.

I log the previous day’s trades into the Bloomberg terminal’s portfolio tool, with the help of which I stay up to date on the fund’s companies’ news reports, the fund’s cash situation, etc. Additionally I log the same trades in a separate table in the cloud, with which it is possible to keep track of investment limits, foreign-exchange-adjusted position returns, and others that the Bloomberg terminal cannot easily do.

11-12
I get a message to replace Timo with Panu for HCP’s virtual meetings. With Timo going on study leave, Panu will handle his responsibilities relating to sports clients. I announce I’ll check the matter.

One previous day’s trade has not gone through fully, and the holding period in a Canadian stock has filled up, so I open the Windows virtual machine on my Mac notebook and through it input via the Infront terminal order SEB (why, oh why does Infront’s DMA connection not work on a Mac?) I shut down Windows but it starts to update itself before shutting down. The computer freezes up and remains unusable for almost an hour.

While waiting for updates to finish, I begin configuring the virtual-meeting system on my desktop computer. Another colleague wants to change the time of availability being offered, so I work on that too. A third colleague calls and tells me that some blog posts do not display pictures. Before that, the CEO has noticed this and has already been in contact.

12-13
When checking the changes made on HCP’s website, I notice a text in which Timo should be changed for Panu and a personal link, which should also be changed from Timo to Panu. The thing is, Panu does not have a profile page to link to. I message my colleagues and inform the webmaster to get the matter fixed.

A colleague comes back to me relating to the pictures in the blog posts. He has noticed the pictures having been linked to MailChimp’s gallery. I use MailChimp for sending out Quant’s investor letters. I ask to upload the pictures to HCP’s server and linking to those.

13-14
I’ve returned from Paris on Monday late at night because of delayed flights. The fridge is empty after a few days’ absence, and my spouse has to leave for another part of Estonia at 2 p.m., so I visit the grocery store, to be able to cook for myself later.

14-15
I continue with the virtual-meeting tool. Panu wants to change his own available times. I notice that not all colleagues’ calendars have included official Finnish holidays in them. I remove an unnecessary user to free up the license to Panu, I do adjustments to date settings, etc.

15-16
I check Quant’s cash situation. I estimate how many Canadian dollars are coming in in two days based on the size of the order and the company’s stocks average trading. I come to the conclusion that there is enough currency in addition to other currency coming in the following day so that at T + 2 there is enough cash in different currencies to take a new position in the fund.

I open the Quant model in the Bloomberg terminal. I start cross-checking data with another party’s database. I check companies’ recent liquidity, I check that there have been no news reports about buyouts (the upward movement is limited) and other checks. A British company listed on Oslo’s stock exchange meets the criteria. Because of the liquidity, forming a position will take 2-3 trading days, so I launch the Windows virtual machine on my laptop and input the order through Infront to SEB.

16-17
I get the idea about logging my day’s activities and start writing up things while I still remember at least part of them. The desktop computer’s trackpad’s batteries are dead and I put them to charge. I continue working on my laptop. I check my work emails and answer those.

I check out North America’s opening at 16:30 and check that all inputted orders have gone through. Everything is in order and the US has for a change opened strongly. I will only find out the final situation about the order after the exchanges have closed down, because I execute them with a VWAP algorithm.

17-18
Because exchanges seem to be in a “normal state” and the weather outside is warm and sunny I decide to go for a 4-km walk to clear my thoughts. I know there is more work to be done in the evening, so it is good to take a break and have some free time before the “evening shift.”

18-19
Cooking, chores (doing the dishes, etc.) and free time.

19-20
Reading HCP’s intranet to stay up to date on what is going on in the company and what my colleagues are working on. Oslo’s exchange has closed, so I log the executed trade quantity and the VWAP into the cloud. For the realized costs, I have to wait for a confirmation calculation, which have been delivered inconsistently recently. I have to ask for these multiple times, which takes up working time for no good reason.

I check the announced and projected quarterly filing dates of all the companies in the Quant portfolio on Bloomberg and log those in for myself in the cloud. At the time of an earnings announcement, a stock can react strongly and a stop-loss can get triggered or a company’s fundamentals can change significantly. This is why I keep an even more watchful eye on the companies at those times.

I browse through the day’s financial news on the Web and quickly check my own Twitter feed.

20-21
I read Bloomberg Businessweek magazine.

21-23
Spending some free time. A movie on Netflix (See You Yesterday).

23-24
American and Canadian markets close. I again log the trades from Infront for myself into the cloud and update the Bloomberg terminal’s portfolio manually up to date. I send a message about the trades executed during the day to the back office so they are aware of these and later input them into the background system, with which we for example calculate the fund’s NAV.

I calculate T+2 currency flows based on the day’s trades and conclude that based on those I can do another purchase. Because I had cross-checked the data already earlier for several companies during the day, I pick the next company from the list. An Asian company is in question. I convert the stock price into euros in order to calculate the correct size for a position. I also calculate a maximum price for the purchase to be certain. I send the order by email to SEB’s Asia trading desk, because I have no direct access to this particular market. I quickly get the answer from them that the order has been received.

The desktop computer has been offering a system update since yesterday, which requires a restart. Because the day’s work is coming to a close, I accept the update and leave the computer to be updated overnight.

On my laptop, I still check an additional email inbox, which receives all order confirmation and which are used as proof in the fund’s value calculations and verification of the holdings. I notice that not all the day’s trades have received confirmations, so I know that the following day will begin with asking for those.

00-01
It occurs to me to check the virtual meeting system’s emails’ content for Panu to check if they are correct. They are not. Simultaneously I notice he needs a license for the software with which to share a screen, so I send a message to the person responsible for that. I check some other settings in the virtual booking system for all colleagues and make small improvements here and there. I decide to continue making the changes the following days, because it starts to get late.

Zzzz-zzz


HCP’s funds’ next subscription date is now in June. You can make a subscription electronically by clicking the button below. Remember that the subscription sum must be visible in our accounts on Friday June 28th at 4 p.m. at the latest, so it is good to make the bank transfer a day or two before.

We will begin producing a newsletter at HCP in which we will tell of our future events and company news. So that you do not miss out on these, go ahead and subscribe to the newsletter.

Book a virtual meeting Make a subscription

Wishing you a warm summer,
Pasi Havia
HCP Quant portfolio manager

“If you are not willing to risk the usual, you will have to settle for the ordinary.”

BarclayHedge: HCP Focus ranked best equity hedge fund in the world

The Finnish investment fund HCP Focus has been ranked the best long-only equity hedge fund in the world by BarclayHedge

See: Barclay managed funds report 1Q 19, page 6.

The Report

The Barclay Managed Funds Report (below: the “Report”) is published quarterly by BarclayHedge, a US-based provider of data on hedge funds and CTAs. (Please note: BarclayHedge is not affiliated with Barclays Bank.)

The Report contains rankings of the 10 best funds across 21 different categories, ranked by their latest 3-year returns.

Eligible for inclusion in the Report are hedge funds meeting the minimum criteria for track-record (at least 3 years) and size (AUM at least 10 $M).

A total of 4,634 funds were eligible for inclusion in the most recently published Report (the 1Q 2019 report, published 29.5.2019), which means that the bulk of all the hedge funds of the world are represented.

The HCP Focus fund (below: the “Fund”) is a global, long-only equity hedge fund managed by the Finnish fund management company Helsinki Capital Partners (below: “HCP”).

In the Report, the HCP Focus fund is listed in the category “Equity Long Only.” In the latest published Report (1Q 2019), this category consisted of a total of 338 funds.

A consistent top performer

The HCP Focus fund was launched 30.11.2012. Consequently, the Fund has been eligible for listing since 1Q 2016. The latest published Report to date is the 1Q 2019 Report. Consequently, the Fund has so far been eligible for listing a total of 13 times.

During the period 1.1.2016 – 31.3.2019, the HCP Focus fund made it to the “Equity Long Only” Top-10 list as follows:

  • 1Q 2016 – rank: 8
  • 2Q 2016 – rank: 4
  • 3Q 2016 – rank: 5
  • 4Q 2016 – (not in Top-10)
  • 1Q 2017 – rank: 7
  • 2Q 2017 – rank: 5
  • 3Q 2017 – rank: 7
  • 4Q 2017 – rank: 8
  • 1Q 2018 – (not in Top-10)
  • 2Q 2018 – rank: 5
  • 3Q 2018 – rank: 3
  • 4Q 2018 – (not in Top-10)
  • 1Q 2019 – rank: 1

During this 13 quarter period, the HCP Focus fund made it to the Top-10 -list a total of 10 times. No other fund managed to make it to the Top-10 -list this many times!

HCP Focus vs. competitors

Other interesting statistics about the BarclayHedge “Equity Long Only” Top-10 -list. During the 13 quarter period 1.1.2016 – 31.3.2019:

  • a total of 55 funds made it to the Top-10 –list at least once.
  • less than half (26/55 funds, or 47 % of the total) of these funds managed to do it more than once.
  • approximately one out of four (14/55 funds, or 25.5 % of the total) managed to do it more than twice.
  • approximately one out of ten (6/55 funds, or 10.9 % of the total) managed to do it more than 6 times.
  • only one single fund – HCP Focus – managed to make the Top-10 -list more than 7 times!

(These statistics are visualized in the attached document: “HCP Focus rankings Barclay managed funds report 1Q 19.”)

All Reports can be downloaded here: https://www.barclayhedge.com/rankings-awards/barclay-managed-funds-report/

(Downloading is free but requires registration.)

Fund pages: https://www.hcp.fi/en/hcp-focus/

The fund accepts subscriptions four times per year. Next subscription day is 28.6.19. Subscriptions: https://www.hcp.fi/en/fund-subscription/

Recent articles featuring the Fund:

https://www.bloomberg.com/news/articles/2018-10-16/one-of-world-s-top-15-fund-managers-reveals-his-next-top-picks

https://hedgenordic.com/2019/04/unorthodox-value-approach-from-hcp-focus/

https://hedgenordic.com/2019/06/hcp-focus-crowned-as-best-long-only-equity-hf/

 

HCP Quant 4/2019 -0.47% | China, China, and China

April went well for HCP Quant until at the end of the month when China’s stock markets turned downwards. China’s Shenzhen Stock Exchange Composite index decreased 3.74% in euros. The Shenzhen Stock Exchange Small & Medium Enterprises index measuring small and mid-sized companies decreased 5.54% in euros. HCP Quant’s return was -0.47% as pressured by Chinese companies.

In the United States and Europe markets did better. The S&P 500 Total Return index rose 4.09% in euros, which is why the fund’s benchmark index MSCI ACWI SMID Value Total Return pushed ahead by +2.65%. The S&P Europe 350 Total Return index measuring Europe’s stock markets also developed well in April and rose 3.82%.

The prospect of a trade war between China and the United States has colored the current week. Stock markets fell yesterday globally as a result of President Trump surprisingly tweeting over the weekend about raising and widening tariffs against Chinese on Friday. Naturally, markets came down especially strongly in China. It remains to be seen if this is just a part of Trump’s strategy to negotiate a better agreement between the two countries. China’s immediate response to the threat was to march the central bank to the arena. In either case the sparring between the countries continues. I believe this week to be especially sensitive for Chinese stocks. Before long I trust that the countries will reach some kind of agreement and the worries concerning tariffs to move away from the present focus.

On a slightly longer time horizon, Chinese stocks are supported by several index changes, which will bring new capital to China’s stock markets. The first changes in indices will happen now in May, but the largest share is coming over the summer and autumn. For small and mid-sized companies, the additions will occur in autumn, which is more relevant for the HCP Quant fund. I wrote more information about the coming changes in February’s investor letter. China’s central bank is clearly prepared to stimulate markets more when needed. When all these things are added up with my belief that there will be a trade agreement between the US and China, markets look brighter to me than present threats, which most investors seem to focus on currently.

Throughout history, valuations at the time of investing have been meaningful for long-term returns. China’s valuations are low. Chinese stocks’ return expectation is around nine percent per annum, when American stocks’ return expectation is below four. China’s return potential is over double that of the US!


We held HCP’s funds’ unitholders’ meeting at the end of April. At the meeting, I discussed my thoughts concerning valuations in markets, China, return expectations, value and growth investing, and of course how the HCP Quant fund has done. You can download the presentation from this link (in Finnish). Our CEO and portfolio manager of the multi-strategy HCP Black fund Tommi Kemppainen gave an illustrative presentation about diversification across different asset classes (available on YouTube in Finnish with English subtitles). The portfolio manager of the HCP Focus fund Ernst Grönblom gave a presentation that can be downloaded from this link (in Finnish).

We at HCP will start publishing a newsletter in which we well inform of coming events and news about the company. To not miss out on this, go ahead and subscribe to the newsletter.

Book a virtual meeting Make a subscription

Wishing you a warm early summer,
Pasi Havia
HCP Quant portfolio manager

“The desire to perform all the time is usually a barrier to performing over time.”
– Robert Olstein

(This text is a translation of the Finnish-language HCP Quant investor letter.)

Diversification protects against risks and allows returns regardless of economic cycle

HCP Black’s portfolio manager Tommi Kemppainen illustrates how the diversification of investments into different asset classes influences return expectations and hedges risks. The video is in Finnish with English subtitles.

Ethical investments – the trend and analysis, Part 2

Authors Ernst Grönblom & Jo Iwasaki

Authors Ernst Grönblom & Jo Iwasaki

Today so-called ethical investments are very much in fashion. However, this trend comes with its own set of challenges. In the second part of this blog series, we talk about what integrity means.

Putting one’s own house in order

This is a well-known story about Mahatma Gandhi. It is probably just a legend. But it illustrates the ethical challenge the financial industry faces beautifully.

There was a woman in India who was upset that her son was eating too much sugar. No matter how much she chided him, he continued to satisfy his sweet tooth. Totally frustrated, she decided to take her son to see his great hero, Mahatma Gandhi.

She approached the great leader respectfully and said; “Sir, my son eats too much sugar. It is not good for his health. Would you please advise him to stop eating it?”

Gandhi listened to the woman carefully, but only said; “Go home and come back in two weeks.”

The woman was perplexed and wondered why he had not told the boy to stop eating sugar. Anyway, she took the boy by the hand and went home.

Two weeks later she returned, taking the boy by the hand. Gandhi motioned for them to come forward. He looked directly at the boy and said; “Boy, you should stop eating sugar. It is not good for your health.”

The boy nodded and promised he would stop this bad habit.
The boy’s mother turned to Gandhi and asked; “Why didn’t you tell him that two weeks ago when I brought him here to see you the first time?”Gandhi replied; “Two weeks ago I was eating sugar myself.”

The moral of the story is that Gandhi lived in such integrity. He would not allow himself to give advice unless he was living by it himself.

Today, so-called ethical investments are in vogue. Customers ask for them: in response, banks and fund managers offer some sort of “ethical funds” or “impact investments”. It looks very much like a question of demand followed by supply.

In some ways, it’s a good thing. People are becoming interested in the role investment plays in making the world a better place.

But what if those who offer such services are not living up to the ethical standards that they demand from others? What if they have engaged themselves in practices less than respectable.

Regulations following the Financial crisis is slow coming. It is only 2018 MiFID II came into effect, aiming to increase transparency and customer protection.  With or without regulations, shouldn’t one put one’s house in order first, before telling others to do so?

This is the core of the HCP concept of distinguishing between “internal responsibility” and “external responsibility”.

In our view, there is a little point in telling others to clean up their act unless we have done so ourselves. Otherwise, we shouldn’t be judging others. One must stop eating sugar before telling others to do so.

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Good asset management is indisputable investment expertise, respect for customers and transparent pricing. This is not all for HCP. A healthier financial sector, better financial service, and support for individuals – this is what we believe in and work for.

HCP Quant 3/2019 Valuation Metrics and Allocation | The Performance Potential of Value Stocks

The stock market kept roaring ahead in March. The first quarter of the year was one of the best in history all over the world. The HCP Quant fund’s performance after fees was +5.18%, which made the first quarter’s return +14.93%. The benchmark MSCI ACWI SMID Value Total Return index’s was 0.86% in euros, and the beginning-of-the-year gain was 14.10%. The S&P 500 Total Return index measuring the development of large US companies rose by 3.41%, making the entire beginning-of-the-year return 15.99%. In Europe, the S&P Europe 350 Total Return made +2.30% and +13.16% respectively.

HCP Quant’s investments’ ratios, weightings in the fund, market capitalizations, and home countries. Situation on March 29th, 2019. Source: Bloomberg

HCP Quant’s investments diversification by country. Situation March 29th, 2019. Source: Bloomberg

The HCP Quant fund’s investments’ quarterly dividend yield since 2015. Source: Bloomberg

The HCP Quant fund’s investments’ quarterly P/E ratio since 2015. Source: Bloomberg

The HCP Quant fund’s investments’ quarterly P/CF ratio since 2015. Source: Bloomberg

The HCP Quant fund’s investments’ quarterly P/B ratio since 2015. Source: Bloomberg

The HCP Quant fund’s investments quarterly P/S ratio since 2015. Source: Bloomberg

The HCP Quant fund’s investments’ quarterly ROE (%) since 2015. Source: Bloomberg

The HCP Quant fund’s investments quarterly EV/EBITDA ratio since 2015. Source: Bloomberg

The fund’s ratios have not witnessed dramatic changes since the last update in January. Generally speaking valuation levels have risen slightly due to markets’ general gains. The dividend yield has risen to 5.85%. The dividend of the highest-yielding US company was actually registered in the fund’s account on the first day of April (the ex-dividend date was in the middle of March.)

In terms of geographic diversification, China’s share has decreased from 37% to 31%. Last year’s average weighting was 29% so the country has approximately the same weighting as before. The share of the US has on the other hand decreased from 20% to 15% and Hong Kong’s share has risen from 7% to 15%. Other countries’ changes were within a few percentage points.


Growth stocks have outperformed value stocks for over ten years now. This will come as no surprise if you have read past HCP Quant investor letters. I have discussed the topic on several occasions. The current period has been favorable to growth stocks long historically. Could it be that we have moved on to a “new normal,” in which valuations no longer matter? A perspective to this question is given by Rob Arnott in his presentation Are Valuations Irrelevant? at the Advisor Symposium 2019.

A large part of investors run after profits. More specifically, after profits that have already materialized. The term for this is yield chasing or trend chasing. The mistake made by many investors is that they project things to continue as before. Well-performing stocks (and investing strategies) are expected to keep performing in the future, and correspondingly poorly performing ones to keep going. In the short term, this does actually happen and this is known as a momentum anomaly. In the long term, this is rendered dysfunctional by the phenomenon of mean reversion.

The last few years have gone specifically as dictated by the development of large growth companies. The list of largest companies is nevertheless very unstable. Since 1980, typically only two companies out of ten have remained on the list of the ten largest companies over the following ten years. It’s windy at the top! Companies disappear from the list because their returns are weaker than those of others. Mean reversion is evident here as well.

The average US mutual fund’s three-year performance (per annum) sorted by prior three-year returns. Data 1990-2016. Source: Rob Arnott

When it comes to funds, Arnott gives an example of how the best-performing funds over a three-year period have been performed the worst over the following three years. Correspondingly, the worst-performing funds over three years have been the best-performing ones over the following three years! When funds are divided into deciles based on their three-year returns, past performance correlates quite strongly with the respective expected future performance. This is once again due to mean reversion. Stocks and investing styles, like growth investing now, go out of fashion. In investing, things occur in cycles with the factors in favor alternating from one period to another.

Value stocks have the greatest performance potential. Source: Rob Arnott

Stocks’ long-term return expectations by country. Lähde: Rob Arnott

Based on Rob Arnott’s predictions, value stocks have the greatest performance potential over the next five years. In the long run, especially US stocks have weak performance expectations. The best performance expectations are in Russia, in Europe, and in developing markets, like in China.

Valuation levels and performance following are strongly interconnected. In the United States, valuation levels are high, which indicates lower returns in the long run, even though the beginning of the year looks otherwise. Many investors nevertheless invest their money in US markets. High and realized gains are like a beehive attracting a salivating investor to itself. If you reach for the hive, be prepared to be stung.

Below is a ratio comparison between the HCP Quant fund and the US S&P 500 Total Return index. Which valuation level’s stocks do you think the market will favor over the next five years?

  • Dividend yield 5.85% (S&P 500 1.94%)
  • P/E 7.10 (S&P 500 18.69)
  • P/CF 5.00 (S&P 500 12.26)
  • P/B 1.46 (S&P 500 3.36)
  • P/S 0.73 (S&P 500 2.14)
  • ROE 21.66% (S&P 500 16.11%)
  • EV/EBITDA 4.60 (S&P 500 13.21)
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Regards,
Pasi Havia
HCP Quant portfolio manager

“No price is too low for a bear or too high for a bull.”
– Unknown

(This text is a translation of the Finnish-language HCP Quant investor letter.)

Ethical investments – the trend and analysis, Part 1

Authors Ernst Grönblom and Jo Iwasaki

Today so-called ethical investments are very much in fashion. However, this trend comes with its own set of challenges. In this series of blogs, we explore some of them and present our responses.

Unfortunately, some of the most aggressive marketers of ethically labelled investments are the very same organisations that, year after year, are caught red-handed in scandals. Money-laundering, tax-evasion, structured products, closet-indexing – the list goes on.

This is unacceptable. Those organisations undermine public confidence in the topic but also in the financial industry.  Given that more than a decade has gone since the financial crisis, ethics in finance should have become the norm.

HCP aims to be a force of good in the financial industry. This is what motivated us in achieving the B Corp certificate in 2017. We have produced the annual Sustainability Report since 2014.

We can do more. We have many dialogues with our stakeholders to understand what ethics means, why it matters, and what they expect from HCP. Our primary stakeholders are clients and employees, but we engage more widely to be on top of the debate.

In this series of blogs, we set out our current thinking on ethics and the role of the financial industry. In doing so, we share our ideas and values. We also draw ideas from thought leaders and from our stakeholders.  In the first part of the series, we discuss why the financial industry exists in the first place.

The purpose of the financial industry

The financial industry functions as an intermediary that enables the efficient allocation of capital and risk. Imagine the economy as a whole is a farm. Then the financial industry is the drainage and irrigation system, collecting water from where there is a surplus and dispensing it where there is a shortage.

Critics of the financial industry like to point out that the financial industry has just a supporting function. It is neither the farm nor water. All production and wealth creation takes place in the fields (that can be said to represent physical industries); capital is the water that provides the resource. The drainage and irrigation system may look like just distributing water to the fields.

But can you imagine the farm without a drainage and irrigation system?

We can also compare the whole thing with the human body. If the economy is the physical body, then the financial industry is the circulatory system that distributes oxygen and other nutrients.

Just like the circulatory system reaches every part of the body, the financial industry connects all industries.

This connectedness leads to many things. Most importantly, what happens within the financial industry affects all other industries. In comparison, the health care industry does not affect the energy industry as much.

This is why responsibility in the financial industry is so important – and hence ethics in finance. If the circulatory system is contaminated, the whole body suffers. Likewise, if the financial industry is corrupt, the whole economy suffers. This is because the financial industry cannot be isolated from the rest of the economy.

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Good asset management is indisputable investment expertise, respect for customers and transparent pricing. This is not all for HCP. A healthier financial sector, better financial service, and support for individuals – this is what we believe in and work for.

One of our favorite banks is a B Corporation

WHEN TALKING about sustainable financial business, some might think setting up solar panels at the headquarters or buying electric cars for executives.

Minimizing the impact on the environment is something that everyone should work on. Above all, sustainability in the financial industry should be about the way of doing business.

LOMBARD ODIER is one of the largest private banks in Switzerland and Europe. It has offered wealth and asset management services to private individuals, families, and entrepreneurs since 1796. The company has helped many of its customers live through 40 financial crises.

What is the secret behind Lombard Odier’s success?

SINCE INCEPTION, the owners of Lombard Odier has run the company. As a privately owned bank, the managers are free from the pressure of external shareholders looking for short term gains. Instead, the company can focus on providing their customers with the best long-term solutions.

Moreover, originally Lombard Odier was an unlimited liability partnership, meaning that the owners assumed liability for all losses with no limit. To this day, the owners commit all their personal assets to the bank. In our view, this is a strong incentive to make sure all the managers think long-term.

Lombard Odier ensures survival through economic cycles by having a recession buffer. A sustainable financial company doesn’t call government (i.e. taxpayers) to rescue during recessions but makes sure to have enough cash at all times. It’s as simple as that.

IN MARCH this year, Lombard Odier received the prestigious B Corporation certification for its environmental and social performance and governance. They are the first global bank to meet the rigorous standards of B Corp.

For Lombard Odier the certification is a natural milestone on their path of making sustainable business. The company has operated with the same healthy principles already decades before the whole ESG discourse had ever emerged.

WE AT HCP, warmly welcome Lombard Odier joining the global family of B Corps. Almost exactly two years ago, we obtained the same certificate.

All our permanent employees at HCP are owners of the company and are thus committed to doing business with long-term goals. Moreover, to maintain our independence we have not diluted our ownership. Like Lombard Odier, we have also saved a recession buffer to make sure we have cash when the economic cycle turns down.

With 40 recessions under their belt (and CHF 259 billion assets under management) Lombard Odier is in its own league. We are still small and yet to face our first recession. But we are confident that we are on the right track.