Birkoa Newsletter 45 (end H1/early July 2024 updates)
Dear Birkoa investors and prospective LPs:
Introduction
As we close the first half of the year and step into July, we’re pleased to report that our hedge fund has performed admirably, delivering over 11% net of fees. Despite facing some initial challenges, the underperforming aspects of our portfolio are starting to show promising results. This positive trend reinforces our confidence in the strategies we’ve employed and fills us with optimism for the future. We believe that even greater successes lie ahead, and we’re excited to share the details of our journey and insights with you in this newsletter.
Before delving into the details of the netwsletter, as always, here's a short succinct summary (prepared by Chat GPT-4o).
Newsletter Summary
Our hedge fund has achieved over 11% net of fees in the first half of the year, with recent gains driven by several key areas of our portfolio:
• VIX and VIXY: Despite a net loss of over 6.5%, our volatility hedge is expected to provide significant returns amid anticipated market volatility due to the upcoming U.S. elections.
• Semiconductors and Pure AI Play: Strong performances from AMD, Qualcomm, Arm, and our investment in SoftBank have bolstered our portfolio, offsetting recent declines in NVIDIA.
• Software-Related Names: The software sector has rebounded, with Affirm Holdings showing a massive upswing due to partnerships with Apple and Amazon, benefiting from anticipated Fed interest rate cuts.
• Regional Banks: Regional banks are recovering, driven by expected interest rate cuts and improving economic conditions.
• Crypto and Blockchain-Related Companies: Despite recent declines, the sector is poised for growth with favorable macroeconomic factors and anticipated rate cuts.
• Chinese EVs and Tesla: Strong Q2 delivery numbers from Tesla and positive developments in Chinese EV companies, including Volkswagen’s stake in Rivian, have driven substantial gains.
• China: Economic activity is resurging, with positive PMI numbers and stabilization in the property sector suggesting potential growth.
• Japan: Strong performance from SoftBank and semiconductor investments, with anticipated currency appreciation expected to enhance returns.
• Commodities: Oil, copper, lithium, and steel investments are performing well, driven by structural demand and favorable economic conditions.
Overall, we are optimistic about our portfolio’s future performance and encourage investors to consider deploying more capital into Birkoa to capitalize on the anticipated market upswing.
Now, here's the detailed newsletter, broken down per topic :-
VIX and VIXY: Our Volatility Hedge
Our volatility index, VIXY, remains underwater and has introduced a net loss of over 6.5% to our fund. However, we view this as a strategic insurance policy against significant market risks, which we anticipate will materialize within the next three years. Despite the current loss, we believe this hedge is crucial for protecting our portfolio against future uncertainties.
We expect heightened volatility in the near term, particularly with the upcoming U.S. elections. The VIX index, often referred to as the “fear gauge,” measures market expectations of near-term volatility conveyed by S&P 500 stock index option prices. Our VIXY strategy leverages this by structuring investments in VIX futures and options, designed to benefit from increases in market volatility.
The forthcoming election poses significant uncertainty, with potential outcomes ranging from the Biden campaign’s continuation to the possibility of Trump or another candidate winning the White House. Each scenario brings its own set of risks and could trigger substantial market fluctuations. Historically, election years are characterized by increased volatility, and we foresee a heightened period of geopolitical and economic turbulence, especially if Trump returns to office.
Despite the current losses from our volatility hedge, we are optimistic about its future performance. As market volatility is likely to peak towards the end of the year, driven by election-related uncertainties and other geopolitical factors, we anticipate a substantial positive impact on our hedge fund’s overall performance. The strategic positioning in VIXY is expected to yield significant windfalls, providing a robust buffer against market shocks and enhancing our fund’s resilience.
Semiconductors and Pure AI Play
The semiconductor sector and pure AI plays have been pivotal to our strategy. Recently, NVIDIA’s 10-to-1 stock split marked a significant event in the industry. While NVIDIA’s stock has seen a decline over the past three to four weeks, its competitors have stepped up, contributing positively to our portfolio.
Advanced Micro Devices (AMD) has shown strong performance, affirming our long-held belief in its potential. AMD’s advancements in processor technology and competitive positioning in the market have been key drivers of its success. This performance is complemented by other semiconductor players such as Qualcomm and ARM, both of which have demonstrated substantial growth.
Our exposure to ARM both directly and through our investment in SoftBank, which owns a majority stake in ARM, has also paid off. SoftBank’s strategic moves and ARM's leading position in semiconductor design have bolstered our portfolio. The convergence of these factors has resulted in a robust performance from our semiconductor holdings, offsetting some of the recent downturns in NVIDIA.
As we look ahead, we remain confident in the semiconductor sector’s potential, particularly with the increasing demand for AI and advanced computing technologies. The growth prospects for companies like AMD, Qualcomm, and ARM remain strong, and we anticipate further gains from these investments.
Software
In our last two newsletters, we emphasized that our software investments had introduced a net loss to our portfolio, with some names being down as much as 40% year-to-date at the time. I had specifically noted that due to a potential shift in macroeconomic policies, such as the Federal Reserve’s interest rate cutting cycle, this sector would likely experience a windfall effect and recover.
Recent macroeconomic data suggesting a cooling labor market, a slowing economy, and decreasing inflation rates have led markets to bet that the Fed will cut rates more than once this year. As a result, and due to higher corporate earnings from these companies, we are seeing a resurgence in their stock prices.
A significant highlight in this sector is Affirm Holdings, which has seen a massive upswing following its announcement of a partnership with Apple, adding to its ongoing collaboration with Amazon. This development has further strengthened our position, as Affirm benefits from the anticipated Fed interest rate cuts.
This resurgence has significantly benefited us, particularly in the past two weeks leading into the close of the first week of July. The improved performance from our software names has helped offset some of the losses from other underperforming areas of our portfolio, such as crypto and NVIDIA, which we will cover later in this newsletter.
Regional Banks
Our investments in regional banks have faced a challenging year, with many of them substantially down from their peaks. However, they are now seeing a resurgence. This recovery is largely driven by the market’s expectation of interest rate cuts due to a cooling economy, a cooling labor market, and an increase in unemployment to 4.1% for the first time since 2021.
The Federal Reserve appears to be signaling a pivot from its “higher for longer” policy, which has been instrumental in the recent uptick in regional bank stocks. As the economy cools and the likelihood of rate cuts increases, regional banks are poised to benefit from the resulting improved lending conditions and economic stability.
This resurgence in regional banks is a positive development for our portfolio, helping to offset earlier losses and reinforcing our confidence in the sector’s potential moving forward.
Crypto and Blockchain-Related Companies
Our investments in crypto and blockchain-related companies have seen a decline, with some down between 10% and 20% from their year-to-date peaks. This downturn has largely been driven by idiosyncratic factors rather than fundamental weaknesses. For instance, the recent mass liquidation order for the bankrupt crypto exchange Mt. Gox led to a sharp drop in Bitcoin prices, which have since partially recovered in the last day and a half.
Despite these technical setbacks, the macroeconomic outlook remains favorable for the crypto sector. The expectation of multiple interest rate cuts by the Federal Reserve, driven by a cooling economy and labor market, is bullish for crypto prices. Additionally, we anticipate that retail money, currently tied up in money market funds and CDs yielding over 4.75%, will flow into the crypto market soon.
As interest rates lower, we expect crypto prices not only to recoup their losses but to reach new peaks by the end of the year. Our strategic investments in crypto miners, blockchain companies, and payment platforms position us well to benefit from this anticipated surge. Although we remain substantially positive in our crypto investments, we foresee even greater profitability ahead as the current stalling phase comes to an end.
Chinese EVs and Tesla
Tesla
Tesla’s stock had been substantially down until about two weeks ago. However, recent developments have dramatically changed its trajectory. Based on their strong Q2 delivery numbers and increased demand from China, Tesla’s stock has surged by over 25% in just two weeks. This unexpected performance has significantly contributed to the recent gains in our portfolio, making Tesla a standout performer.
Chinese EV Demand
The positive delivery numbers from Tesla in China have had a ripple effect, lifting the stock prices of Chinese EV companies as well. We own shares in nearly all publicly traded Chinese EV companies, including BYD, Xpeng, and Li Auto. These companies have also shown excellent performance recently, further enhancing our portfolio’s value.
Additionally, Volkswagen’s recent announcement of taking a significant stake in Rivian, one of our long-term holdings, has led to a surge in Rivian’s stock price. This strategic move by Volkswagen has been another net positive for our portfolio, reinforcing our optimistic outlook for the EV sector.
The surge in demand for EVs in China, coupled with Tesla’s optimistic outlook, has been a net positive for our investments. We expect this trend to continue, with both Tesla and Chinese EV companies driving substantial gains. This has been a welcome and pleasant surprise, adding robust momentum to our portfolio’s overall performance.
China
China is experiencing a resurgence in economic activity, as indicated by the recent Caixin PMI numbers for June. Although the recovery is not very strong yet, these positive indicators suggest a potential upswing in the near future. The property sector, while not yet seeing a full resurgence, has stabilized and is no longer plummeting to new lows. This stabilization is a positive sign that the sector might be on the path to recovery.
Additionally, the broader Chinese technology sector and the Hang Seng Index have been experiencing more up days than down recently. This positive trend is likely a result of encouraging economic indicators, supportive government policies, and efforts to bolster the markets and the economy.
As reflected in the strong performance of Chinese EV companies mentioned above, China appears to be gearing up for a significant economic takeoff. This potential recovery is particularly exciting for our fund, which has seen China-related investments underwater for over two years. A strong performance from China could lead to substantial parabolic returns, significantly boosting our overall portfolio.
Japan
Our investments in Japanese equities have been very positive, largely driven by our significant position in SoftBank. This strong performance is encouraging, especially as the Japanese yen has broken new lows against the dollar, continuing to weaken.
Despite the currency devaluation, we are optimistic about our other Japanese positions, particularly those related to semiconductors. We believe these investments will substantially go into the green as the yen weakens. Even when the yen stabilizes after a few months, we do not expect the Japanese markets to relinquish their gains.
Over time, we anticipate substantial returns from our investments in Japan, driven by the dual forces of our semiconductor holdings and SoftBank, which is a major AI bet. These sectors benefit from significant macroeconomic, geopolitical, and structural drivers propelling them forward.
Furthermore, when we eventually liquidate our Japanese positions, we expect the yen to be meaningfully higher—around 35% to 40%—against the dollar than it is today. This currency appreciation will provide us with compounded returns on top of our existing gains when we convert back into dollars, amplifying the overall profitability of our Japanese investments.
Commodities Overview
Our commodities positions have been performing well, contributing net gains over the past couple of months. While these gains may not move the needle as significantly as our AI investments or strong performance from China, they are steadily enhancing our portfolio’s value.
Oil
Oil has seen a remarkable recovery, rebounding from a low of $73 per barrel to $83 per barrel within a short span of a month. This resurgence is driven by seasonal demand and continued supply cuts signaled by Saudi Arabia. We anticipate oil prices to keep rising, supported by these catalysts.
Copper and Lithium
Copper and lithium miners have also performed admirably. The demand for copper is particularly noteworthy due to its essential role in the AI boom. As data centers and servers are built to support AI infrastructure, the need for copper as a raw material has skyrocketed. This structural demand is expected to continue driving copper prices higher.
Steel and Commodities Exporters
Our positions in Brazilian exporters dealing with steel, along with other commodities miners and plants, are also doing well. The anticipated dollar weakness and interest rate cuts by the Federal Reserve are expected to further boost these sectors.
Overall, while our commodities positions may not be the largest drivers of our portfolio, they are reliably performing and poised for continued growth. The intersection of macroeconomic factors and specific industry demands, particularly in copper due to the AI boom, bodes well for their future performance.
Conclusion
In conclusion, the other portfolio sectors we have discussed in prior newsletters remain intact. While there may not be significant updates at this moment, we will promptly inform our investors should any material changes occur, especially in areas like defense-related names.
Overall, our portfolio is performing well, with unexpected areas such as Tesla and Chinese EV companies driving recent gains. The stalling in sectors like crypto gives us hope for significant positive swings in the near future.
We encourage our investors to consider deploying more capital into Birkoa, as we see a tremendous upswing on the horizon. Our volatility trade, currently a net money-losing position, holds the potential for asymmetric returns should market conditions change abruptly. Even in the absence of such events, our diversified strategies continue to generate steady returns.
With macroeconomic forces aligning favorably, including anticipated interest rate cuts and sector-specific demand drivers, we are gearing up for the next significant upward phase for our portfolio. The future looks bright, and we are excited about the opportunities ahead.
Sincerely,
Pranjit K. Kalita
Chief Investment Officer