Birkoa Newsletter 42 (end of December '23 updates)
Dear Birkoa LPs, prospective LPs, and friends,
I'm sending an end-of-month update on our fund's status and progress. Here, I will report on how we finished the year 2023 and what I foresee on the horizon for 2024, which might continue to be quite lucrative for us. I will first provide a summary of this newsletter followed by the full newsletter. Per your convenience, feel free to digest either or both.
First, for those of you with limited time, here's a crisp summary of what the newsletter talks about (generated by Google Bard) -
Birkoa Fund Performance and Outlook - December 2023 Newsletter Summary (with emphasis on significant points):
Key points:
Strong 2023 performance: 43% net return after fees, outperforming the market by 20%.
Positive outlook for 2024: Tailwinds from a crypto bull market, weakening Dollar, rate cuts, and China's economic recovery.
Continued diversification and alpha: Fund aims to outperform through both asset diversification and individual asset outperformance.
Increased participation expected: While 2 assets drove outperformance in 2023, broader participation across assets is anticipated in 2024.
New capital deployment encouraged: Macro conditions are favorable for deploying new capital.
Highlights per asset category:
AI (U.S.): Continued growth anticipated, further bolstered by manager's personal academic background.
Crypto + Blockchain: Strong performance expected within the bull market, focus on equities over tokens.
China (AI + Property + Tech/EV): Market poised for rebound due to economic recovery and government stimulus.
Japan: Markets expected to benefit from loose monetary policy and semiconductor demand.
Commodities: Oil and lithium potential upside seen.
Semiconductors: Strong year anticipated, particularly for AMD, ARM, and Qualcomm.
Regional Banks: Continued upside potential expected until mid-2024 due to rate cuts.
New FX spot trades: Short USD/JPY, USD/CNY, and USD/INR seen as profitable due to Dollar's decline. These trades offer high return potential with small downside risks.
Short-term volatility hedge: VIX position providing downside protection, with potential for massive gains in case of market shock. Asymmetric risk-reward potential given entry point for hedge.
Overall, the Birkoa Fund is optimistic about 2024, expecting to benefit from favorable macro conditions and continued outperformance across its diversified portfolio. The newsletter also emphasizes the potential for new capital to gain from promising FX spot trades and the fund's continued focus on both diversification and alpha.
Now, the following section contains the full newsletter :-
December was as good to us as November, yielding a 13% net gain after fees. This places us at a 43% net return after fees for 2023, substantially beating the market by ~20% for the year. We outperformed nearly all, if not all, major global indices this year. For context, we returned over 50% in gross returns (before fees) for 2023, a decent benchmark to signify our strong year.
Over the life of our fund (since May '22), we're up meaningfully relative to most, if not all, major market indices during that period. The macro environment is becoming more conducive to our anticipations, per our strategy's framework. We expect to continue delivering this outperformance now that both cross-asset correlations and macro conditions are aligning with our strategy. Birkoa’s fund employs what I call “diversification yet alpha”, meaning we have geographical and asset diversification, with each having its independent characteristic/potential to outperform. The prior 18+ months saw headwinds which presented short-term turbulence, but now that we’re through, we expect that independence to shine through more. This means we might get the best of both diversification and alpha (outperformance).
Diversification doesn’t only mean being hedged all the time. In 2023, our outperformance was driven mostly by 3 out of 7 assets. Now we expect broader participation. So, while we are very glad that the “hedged” part of our hedge fund strategy worked last year, now we might see a more uniform performance with broader participation across assets. So, a different way to make money but perhaps more fulfilling, since ultimately, given our ~3 year time horizon, we expect a 65-70%+ strike rate per position.
This remains a well-suited time for the deployment of new capital. Our fund has withstood quite a lot of storms over its life, ultimately delivering even in the worst of headwinds. Now, we expect relatively calmer skies - a crypto bull market, Dollar weakening following its artificial rise, Fed lowering of rates, China's economy bottoming out, etc., being the most significant anticipated tailwinds.
Furthermore, I will briefly highlight a few currency trades for upcoming new capital that could prove quite lucrative for us in the medium term.
We're in a very privileged position to have been able to maintain our losing positions because of outperformance from other assets. Now, we think new capital could benefit even further given that more factors are aligning to see a majority of assets rally.
Let us very briefly look at where we stand per each of our roughly 7 asset categories - not much has changed since my last couple of newsletters on these, so I'm roughly recapping and remaking the case for why we're primed for continued upside in our portfolio:
AI (U.S.) - Already been great for us, but with rate cuts incoming coupled with the faster rate of growth and adoption within Generative AI for businesses, we expect this year to be net positive for this sector. Also, from a purely technological standpoint, the state of development and the rate of growth within AI are immensely exciting to look forward to, and 2024 could mark a significant step towards Artificial General Intelligence (AGI). Given the technical nature of these companies and the increasingly macro implications for GenAI, my personal academic background could continue to provide an added premium that may drive lucrative returns for our fund. Therefore, we are well-positioned from multiple perspectives to take advantage of this asset category.
Crypto + Blockchain - Been great for us in 2023, and now we're in the middle of a crypto bull market. Given that we're not in crypto tokens themselves but in equities that have a correlation to crypto prices, we're shielded from the downside effects of volatile crypto token movements while maintaining their upside. For example, Coinbase, our major holding in the area, made over 250% in 2023, whereas Bitcoin made 163% and Ether less than that! Given that the regulatory environment is finally adapting to the sector's favor, we expect to continue seeing upside in our blockchain equities holdings, both via our Coinbase position and the Blockchain ETF, which gives us an eclectic mix of blockchain utilities and applications ranging from miners to payment platforms.
China (AI + Property + Tech/EV) - As mentioned in prior letters, the Chinese economy is bottoming out, and the markets there have become fatigued and exhausted with the selloff over the past 1.5+ years. The Chinese Communist Party (CCP) seems to understand the need to boost their economy via monetary stimulation that's battling deflation (a different stage of the debt cycle than the U.S. or Western countries battling inflation). Being in a deflationary environment, as I've suggested before, we expect lots of stimulus programs and fiscal-monetary coordination, similar to post-GFC in the U.S.. That, coupled with the CCP recognizing the need to bring back foreign inflows into China, could prove strongly bullish for Chinese markets at any time. And as we saw during November '22-January '23, the rise is parabolic. So, we're just staying put and any new capital would be deployed partly here to fuel our uptrend.
Japan - In the short-term, we timed our entry wrong in Japan, but by and large, our losses are contained and range-bound. The Japanese economy, however, is finally growing for the first time since 1989, which is expected to be bullish for its markets. The Bank of Japan (BOJ) ultra-loose monetary policy with Yield Curve Control (YCC) is expected to last until at least the first quarter of this year, which might help fuel more of a rally in the equities market in the earlier part of the year. Remember, the markets traded sideways towards H2 of 2023 in anticipation of the end of YCC, but now the BOJ is increasingly calming sentiments by suggesting a gradual easing approach. In the longer run, however, some of our Japanese plays have been bets on semiconductors and the macro-geopolitical landscape, which we expect to benefit Japan and Korea. That seems to be increasingly playing out. On another note, our holding Softbank got a windfall from a previous deal which has propped that stock up recently, while obviously benefiting from its ARM holding (Softbank is the majority owner of ARM and held 100% of it prior to its recent IPO) and the upcoming low-interest rate environment, which will only help with the valuations of its privately held venture businesses. We're expecting deal-making in venture capital (VC) to pick up as a result of the macro environment in the U.S. easing, which will be beneficial for Softbank, being the world's largest VC.
Commodities - Oil has been net positive but underwhelming. We believe oil demand is more than what the markets are discounting for, plus supply issues too haven't gone away. This is why we've held on to oil and at these ranges ($70-75/barrel), the potential downside is limited given the plethora of geopolitical uncertainty (Russia-Ukraine war, Iran's Red Sea excursions of late emanating from the war in Gaza, etc.).
Lithium and some of our lithium miners have suffered significant drawdowns during the course of 2023 on demand fears over EVs, but now with the Fed moving to manage the business cycle and boost the economy, the extent of those fears seems to have been overdone. Furthermore, Chinese EV sales have been surprising on the upside of late (Nio, BYD, Li Auto latest reports), and so we believe a pickup is near in these Lithium-related holdings.Semiconductors - Driven by furious growth in GenAI, and of late a comeback in demand from the consumer as seen via great Q3 Micron results, we expect this year to continue being good for semis. We're expecting to see an especially good performance for AMD, ARM, and Qualcomm this year, which lagged NVIDIA in 2023. A very recent academic paper from Apple called "LLM in flash", lauded as a breakthrough of sorts for hardware allowing on-demand, in-memory processing of LLM models locally on-device rather than on the cloud, could take this GenAI revolution into mobile and personal computers. That in turn, would be immensely beneficial for these 3 chip designers.
Regional Banks - We've already made a multiple of our investment in this area since the regional banking crisis began in March 2023, and expect it has more room to run at least until the middle of 2024, given the incoming rate cuts by the Federal Reserve. Being beneficiaries of rate cuts which thin their asset-liability mismatch and stop the bleeding of depositor funds, we expect another 25-50% upside potential per holding within this sector, which will march on for the better part of this year. This is why this very profitable bet for us is a hold even now, and expected to continue to do well for us short-to-medium term.
New Trades lined up in FX spot -
All these trades, which I have spoken about going back to summer 2023, are predicated on the U.S. Dollar's artificial rise ending, which in turn was precipitated by the Fed's historic rate hikes from 2022-23. We had anticipated in summer that the end of said hikes was closer than most people realized, which is why we felt the Dollar had to decline. Now with inflation under control and the Fed having pivoted to managing the business cycle over worrying about inflation, the Dollar is on a strict downward slope. A couple of these (USD/JPY and USD/CNY) also provide us with a hedge against currency exposure since we are invested in both Japan and China. Although in the case of China we're invested in Hong Kong, the fact remains that we've borrowed Dollars to invest in Hong Kong, and the Hong Kong Dollar (HKD) has gone up slightly since we first went in, which in turn is dependent on the strength of the Chinese economy, signified by the Yuan (CNY). The same thing with the Japanese NIKKEI stocks we're invested in.
Each of these FX trades has limited downside but high return potential.
(I can only make these trades once the fund assets are high enough for the brokerage to give me the leverage ratios needed to make meaningful trades out of them. Which is why I've been encouraging new capital to come in ASAP, so I would be able to take these positions.)
USD/JPY short - More meaningful because the Japanese Yen, otherwise known for its stability globally, had fallen to record levels against the Dollar, and just on an unleveraged basis alone, would account for over 30% gains once the Bank of Japan normalizes its ultra-loose monetary policy. Once it hit 155 on the Dollar-Yen last summer, I have been eyeing this trade (normal trading range around 100 for Dollar-Yen). So, with a leveraged bet of 50:1 or 100:1 (very standard for FX spot trades), you can imagine the manifold returns of this trade that's been staring at us.
USD/CNY short - While not of the same return potential as the Japanese Yen, it's still worthwhile to think that the Dollar's artificial strength compounded with the lackluster Chinese economy has led the Chinese Yuan to its lowest levels against the Dollar since 2005. Now that we expect both scenarios to tilt, couldn't be a better moment to get in on this trade. Expect to see a minimum 10-15% movement on this pair over the next year if not sooner.
USD/INR short - While we do not have a position on Indian equities as of yet, we intend to very soon (due to min. AUM requirements, we do not have permission to trade in certain markets like India and Korea - which we expect to meet very soon). However, the Indian economy has been roaring and is probably the most likely to do well among EMs this decade, given the country's victory over inflation, high growth rate, and highly-technical labor force with a high-tech economy. The Reserve Bank of India is easing policy but that easing is expected to fuel its tech-led growth; furthermore, India is a major beneficiary of the U.S.-China supply chain disruption with industries like high-tech manufacturing and semiconductor fabrication being moved there to hedge for the icy relations between China and the U.S.. Over the past 4.5 years, the Indian Rupee has suffered a major devaluation crisis emanating from a mix of foreign outflows over its increasingly nationalistic government (since reformed at least when it comes to commerce), a Non-Bank Financial Companies (NBFC) crisis coming out of its unregulated growth of microlending programs post-demonetization of Modi from 2014-16, and due to the Dollar's artificial rise. But now considering that the macro environment is changing, with the Indian Rupee hovering at its lowest levels ever against the Dollar at ~83 for USD-INR, that is about to change in a meaningful way to account for a minimum 20-25% upside over the next few years. This is why this is an incredible trade to get involved in while we await direct exposure to Indian stocks, which will fuel meaningful global growth over the next decade.
Finally, our hedge on being long short-term Volatility (the VIX index) has dampened our portfolio by 1.5% since we put it on at the beginning of December. As suggested in my prior newsletter, that is the intended effect; the good thing about this is that we indeed seemed to have been able to get in at peak fearlessness/record low VIX, having oscillated around this range for a month now. Come any short-term market pullback, this will continue to provide protection to us overall and we expect to at minimum not lose our recent winnings in net (but in all likelihood, given the mismatch of VIX levels with current global geopolitical uncertainties and how it has normally traded in the past, we should make more than we lose should any shocks occur).
Sincerely,
Pranjit Kalita
Chief Investment Officer