On day one, the fund had assets of circa EUR 10 million, which included the liquid net worth of the two founders and an anchor investor. Today, the founders continue to reinvest most of the fees generated into the strategy (after covering management company expenses). Eschewing seeders, the duo owns the management company.

Though Sweden has for decades been famous for letting retail investors access hedge fund strategies, Ridge Capital (“Ridge”) deliberately chose a Luxembourg RAIF structure that they had prior experience of, and which is only open to well-informed professional investors in the EU and qualified as well as institutional investors in Switzerland. “This gives us a stickier investor base that is not subject to the short-term flows of daily dealing retail funds. We like to see our investors as long-term partners,” says Levin. Ridge focuses their marketing on tickets of EUR 1 million or more, though the structure can accept EUR 100,000.

Most of the investor base are financial market professionals including single and multi-family offices, high net worth individuals, pension plans, endowments and some smaller and medium sized institutional investors. Some of the investors are also “friends of Ridge Capital”: a network of company owners, executives, lawyers, hedge fund, private equity and venture capital founders and partners, who provide valuable intelligence on specific companies and industries. “We use them as a sounding board to get an edge and gain insights that we believe are difficult to get from management, company owners, analysts and sales,” says Malmström.

Malmström was previously part of a Nordic high yield manager that outperformed its peers and was the top performing strategy. He also has experience of private debt and direct lending, but currently judges that it offers no yield pickup vs public bond market, at least in the Nordics: “We see better risk/reward from the relatively imperfect and inefficient Nordic bond market. We do not want to be locked into a loan for 5-7 years and do not need to reduce volatility, which is a driver for many to invest in private markets”. Levin, a seasoned banker, most recently from UBS, also has a broad investment background. Until today the two founders have worked closely on the portfolio management, and in September a third portfolio analyst will join the team.

Nordic yield pickups

Private debt might be relatively less attractive in the Nordics simply because public high yield already offers a ~2% pickup over continental European high yield. Ridge does not think that commodity exposure explains the pickup as this is mainly relevant in Norway. Malmström reckons that the yield pickup is mainly related to illiquidity and smaller issue sizes, and the absence of credit ratings on most paper, since ratings are prohibitively expensive for small issues. The potential investor universe may be smaller if giant asset managers cannot deploy enough capital. Additionally, Ridge knows of no CLOs in the Nordic market, though some pan-European CLOs may buy Nordic issues. They are also not aware of any ETFs or investible indices, although Malmström observes that, “The larger UCITS funds in the region follow a buy everything approach, akin to a passive index strategy”.

Low correlation

The correlation between Nordic high yield and equities has averaged 0.1 and sometimes even been negative, whereas European high yield has shown a 0.6 to 0.7 correlation to equities. This is partly due to illiquidity, but also because most Nordic bonds are floating rate. With three-month rate resets, interest rate duration is very low, and Ridge has not felt the need to use any interest rate hedges, though they could do so.

Mainly Nordic companies

Ridge mainly invests in Nordic issuers, although their flexible mandate allows them to invest in issuers from other Northern European countries as well e.g. Germany, Netherlands, UK and Switzerland are fairly common in the Nordics, attracted by minimum issue sizes of EUR 50 million, 90% smaller than many Eurobonds. Equally, some Nordic companies such as large Swedish real estate firms may issue bonds in the more liquid Euro market. Most of the currency exposures are SEK, NOK or EUR. Though Ridge does not trade the largest USD denominated Nordic bond market, namely oil and gas paper in Norway, banking AT1 bonds can occasionally be USD denominated. Ridge invested in such bonds especially after March 2023 when the mini-banking crisis created a useful entry point.

The asset class is broadly attractive, but Ridge uses four main strategies for outperformance. Firstly, buying performing credits, avoiding defaults and earning carry to maturity. Secondly, buying at a discount in the secondary market to earn extra returns from pull to par. Thirdly, event driven investments looking for catalysts such as a rights issue that could be positive for creditors. And fourthly, they look for Nordic issuers that have multiple bonds in different currencies, but where the local currency bonds are trading at a lower spread. This is usually driven by the local investor base’s appetite for local FX, and this discrepancy tends to get evened out by the market, creating an opportunity for short-term gains at low risk. Typically, two thirds of the book could be income seeking, though some of this is opportunistically acquired at a discount in secondary markets, and one third may be in catalyst or event trades.

Mid-teens returns

The return target is STIBOR +7% per year, including leverage and after fees. In May 2024 spreads of 600 basis points on top of the 3-4% risk free rate provides a contractual yield of 10% without leverage. Leverage up to 50% could add about 5% to this. The borrowing costs are about 1% over STIBOR.

The timing of their launch in early 2023 was ideal to take advantage of a stressed credit market. In 2023, about 60% of returns came from coupons and 40% from price increases. Over the next year, coupons should contribute more as bond prices have already risen significantly after the market recovery in 2023 and 2024.

Mainly performing debt

Though 80% of the book has no credit rating, Ridge produces their own “shadow” ratings, focused on cash flow generation to service debt and strong asset backing, estimating an equivalent credit rating between B and BB.

Ridge defines “non-performing” as where, “We think there is a severe chance the company may not be able to service its debt and debt holders may have to accelerate the bond and pledges. We can invest in these situations when we have strong conviction, and generally because we think acceleration will be a negotiating tactic,” says Malmström.

Ridge does not play in distressed or loan to own, though they have experience of it. “Before starting Ridge, I participated in several debt for equity swaps and restructurings as part of my previous roles, which can be profitable though they can take time and resources,” says Malmström.

The fund mandate maintains the flexibility of potentially owning some equities mainly to permit freedom to participate in debt for equity swap situations. Separately, Ridge can own some equity linked securities, such as convertible bonds.

Avoiding 2023 defaults

The Swedish corporate debt market saw a default rate by volume of ~4% in 2023, according to Stamdata, with several notable ones including Cabonline, Kvalitena and YA. These were trading at deep price discount and high yields, but Ridge determined that the risk reward was poor: “We screen bonds through multiple filtering steps of cash flow generation, weak management, weak business models, weak covenants, high valuations, exogenous risk factors and poor ESG, as well as feedback from their own networks,” says Malmström. Ridge likes to see tight covenants with restrictions on distributions, as well as incurrence and maintenance tests.

Sector wagers

Ridge has recently been overweight of financial sector, e.g. banks and investment companies, and the real estate sector. They have been more cautious on private equity owned issuers given the typically aggressive capital structure, loose documentation and covenant levels. Ridge started increasing real estate in late 2023 as rates came down and to exploit some very underpriced special situations. By May 2024 the real estate sleeve had reached the maximum 25% sector weight. “The exposure is mainly residential where there is strong demand, rents have risen with inflation and funding costs have decreased,” says Malmström.

Most of the book in mid-2024 was in Sweden, but in late 2023 the majority was outside Sweden. Ridge does not expect to have an edge in macroeconomic forecasting but take a bottom-up view that regulation, debt management, creditworthiness and generally low default rates make the Swedish market attractive.

Leverage and stress tests

Leverage has ranged between 1.25 and 1.75 times. It can be tactically reduced to raise some dry powder, perhaps ahead of a possible summer lull or pullback. The leverage is secured on the portfolio. “A margin stress test would have been able to withstand more than double the 20% Covid drawdown in Nordic high yield seen in 2020 or the 30% drop in European high yield in the GFC,” says Malmström.

Crisis hedges

Index shorts are nonetheless held to protect against a big dislocation such as a Covid crash or the March 2023 mini-banking crisis. “We buy e.g. puts on CDS index to hedge the portfolio for significant spread widening, which of course would have a negative on the prices of our existing holdings. The aim is to spend ~2% per year on hedges, which is a small part in relation to the leveraged gross yields of 17-18% in the portfolio now,” says Malmström. Currently puts on iTraxx crossover are used, but Ridge has an open mandate to use option spreads, other instruments, different maturities, and so on to optimize cost and correlation.

Active portfolio management

Portfolio turnover is around 50% a year. Given an average tenor of 3-4 years, one third of this is just natural churn from maturing or refinancing bonds. Primary issues can make up as much as 30-50% of the book, which is less than for larger funds with more capital to deploy. For such funds primary market issues is the only way to invest, as volumes in secondary market are too low to meet their minimum holding requirement without moving market prices.

Modest capacity

Smaller issues mean that fund inflows and outflows can have a disproportionate impact on some funds with daily liquidity, and Ridge is very conscious of capacity constraints. Ridge has already raised EUR 100 million, about one third of its NAV capacity of EUR 300 million. Capacity including leverage of ~1.5x is about EUR 500 million, which is about 1% of the Nordic high yield market of EUR 50 billion. Market size is the criterion rather than average daily trading volumes because they are quite lumpy and much lower over the summer. “We would rather be the best than the biggest and want event driven trades to make a difference. We are not a buy-everything fund,” stresses Malmström.

Proprietary ESG analysis

Ridge’s ESG policies exclude about 20% of the universe, mainly oil and gas, oil services and exploration and production. Alcohol, tobacco, pornography, gambling and weapons are also off limits. Nuclear is investible but there are no local issuers. Shipping is not on the exclusion list, but spreads are currently too tight.

Ridge has developed their own questionnaire to help plug gaps in ESG ratings agency coverage. “We have discussed with many ESG data providers but given the small size of companies we invest in, these providers tend not to have very strong coverage,” says Levin.

Ridge aspires to report carbon footprints as data improves. “Currently perhaps 50-60% of firms are reporting carbon data, and it is advancing rapidly in the Nordics,” points out Levin.

The fund reports under SFDR 8. Ridge decided at the outset to avoid SFDR 9 due to a lack of clarity around the rules: “We would rather under-promise and over-deliver on ESG,” says Malmström.

Outlook

Malmström sums up: “We work hard to outperform our peers and raise capital from investors. We will continue to build the team and recruit as the fund grows in size. We may consider new adjacent strategies when the time is right. They will be in a market where we can have an edge. One veteran Nordic investor legend compares today’s high yield market to equities in the 1980s, describing it as an ‘inefficient, illiquid, and imperfect market.’ Those are the types of information edge opportunities we seek.” υ