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Hedge Fund Interview with Hakon Halvorsen, Investment Manager of the Sector Enhanced Relative Value Fund

Sector Asset Management (SAM) is a leading edge, independent, specialist capital management firm, managing both absolute return and long only mandates. Eurekahedge speaks to its Investment Manager Hakon Halvorsen, in this 2005 interview. With a current AUM in excess of US$1.2 billion, SAM started to diversify its product offering outside the energy and transportation areas in 2004. Hakon Halvorsen joined SAM to form a new investment team who will manage an equity market neutral fund based on Hakon's proprietary investment models.

This new fund by the name of Sector ERV (Enhanced Relative Value) was launched on 8 June 2005, with US$23 million from institutions and professional investors. The fund targets average annual returns of approximately 12-22% and volatility of approximately 10-13% (a Sharpe ratio of 1-1.5). The Dublin-based and listed fund is offered in euro, dollar and Norwegian kroner share classes.

  1. Could you tell us briefly about your investment strategy?

    Sector ERV is a market neutral, global equity hedge fund investing strictly according to a proprietary contrarian method. The fund basically plays two spreads in managing the portfolio; a relative value spread and relative share price spread. The fund is focused on sectors where the investment process has yielded strong results, and those are telecoms and banking.

  2. Your investment mandate is global equities. How do you go about selecting your investments?

    The "relative value" part is the foundation of the ERV process. We divide our universe into peer groups based on geography and sub-sectors, performing valuation analyses separately for each of these. After "cleaning" analyst estimates, primarily to get a common financial year-end for all companies within each peer group, we graphically display specifically-chosen valuation multiples relative to the factor we feel are most important to each multiple (eg. P/E versus growth in E, or P/BV versus ROE). Exponential correlation analysis is applied to calculate each share's upside or downside on each valuation graph, and the results are then weighed using the various correlation coefficients to determine the share's overall upside or downside. Due to thresholds for target returns the relative value analysis allows us to screen away 70% of the universe at any given time, so that we may focus our fundamental work only on the most interesting long and short candidates. This includes quality control of estimates, understanding the investment case for the share within the investment community, and the identification of fundamental triggers (events). Being based on correlations, the method by definition identifies as many short candidates as long candidates, and we thus avoid the typical hedge fund trait of buying single stocks against shorting indices.

  3. Can you tell us more about the significance of the "timing tool" used in your investment process?

    The timing tools constitute the "enhancement" part of the ERV process. While we consider fundamental and market data input, the main timing tool consists of proprietary designed relative share price graphs to which we apply trading rules that we have developed and extensively back-tested.

    The aim of these graphs is to identify when a share price has deviated from its peer group to an extent that the probability of a short-term mean reversion is significant. We use the graphs to (i) get a good start to a new position as we will wait to take it on until the timing looks favourable, and (ii) to control risk as we will close the position when the timing looks unfavourable. Thus we may take on and close a desired fundamental position several times en route to our share price target.

  4. Do you have any preference for small-cap, mid-cap or large-cap stocks? Any reasons for that?

    We do not have any such preference although at times we may have a specific bias if we believe that any of the above are overvalued or undervalued as a group, or have short-term outperformed or underperformed beyond reason. For instance, with the VIX-index presently below 11 for the first time since 1995, we have gone long large-caps and short mid/small/micro caps. This implies we have taken a short-term measured bet versus the current mergers and acquisition frenzy, which is also what the timing tool is telling us.

  5. What is the exit point of your investments? Do you have any predefined standards for that?

    Fundamental exits happen either due to changes in estimates or because the target price has been reached. Temporarily we may exit any investment based on our "timing tools" as described above.

  6. How strong is your research on companies in which you invest? Do you conduct company visits, attend industry seminars, etc?

    Although we visit companies and attend industry seminars, traditional research is only performed on the long and short candidates we feel the strongest about. But we never make our own estimates on the companies.

  7. Do you have had any direct experience of managing a global long/short fund?

    My experience consists of 43 months managing two global long-only equity funds and 11 months managing two market-neutral equity hedge products (including 6 months with Sector ERV, which started as a discretionary mandate on 1 Jan 2005). The common denominator for these 54 months is the ERV approach, which continues to be developed to this day.

    As a long-only manager I managed a total of US$100 million, and for the hedge products the weighted average capital under management for the 11 months is US$10 million.

    The long-only funds outperformed their benchmark by 1% per month, and both achieved Morningstar 5 rating. The average monthly performance over 11 months for the hedge products is also 1%. Overall, measuring long-only performance relative to benchmark and hedge performance relative to zero, I have 9 negative months out of 54. However, due to a bad June (first negative month since Dec. 2003), the Sharpe ratio YTD for the ERV product is only 1.04.

  8. Could you briefly tell us about your other team members?

    I have been able to recruit my trader from the long-only days, Inger-Anne Varmann Vikre. She will join me 1 September from DnB NOR Asset Management, where she has seven years' experience from global equity trading. Her responsibilities will include surveillance and maintenance of the timing tool chart library, trading, back-office registration and corporate actions. Inger-Anne holds a bachelor's degree in finance from the Norwegian School of Management.

    Mads Andreassen (born 1980) will join late September from an internal team. Mads will work as an analyst, assisting me with maintaining and developing the relative value models, project analysis, and will also add earnings surprise competence as he has worked on earnings surprise methodology the last year. Mads holds a master's degree from the Norwegian School of Economics and Business Administration.

    Sector Asset Management will provide all other functions.

  9. What makes you different from other funds based in Europe offering a similar product?

    We do not know of any other fund offering a similar product. What makes us different is that Sector ERV is a market neutral, equity hedge fund yet with a relatively high risk/return objective (10-13% target volatility); we combine our relative value fundamental valuation techniques with an active trading strategy instead of a buy-and-hold approach. And we are not starting from scratch, the ERV method has achieved double Morningstar 5 track record within long-only, good returns over 11 months within market neutral equity hedge, and has averaged only two negative months per year these last 4½ years.

  10. Finally, you already have raised US$23million for your fund. What do you target your fund's closing size to be?

    We expect to soft-close the fund at around US$200 million but believe that ultimate capacity could be higher due to the nature of the sectors chosen. Are you confident of raising additional money? Yes, we are reasonably confident of raising additional money as people seem to like the logic of the method and the track record. The AUM has already risen to US$30 million, and we hope to pass the US$50 million mark during the fall.

Contact Details
David de Picciotto
Sector Asset Management
47 2301 2900