Birkoa Newsletter 47 (recent market volatility RE:)
Dear Valued Investors and Prospective Partners,
We are pleased to present our latest newsletter, which provides a comprehensive analysis of recent market events, our fund's performance, and the significant opportunities we see on the horizon. This communication is designed to offer you clear insights into our strategy, performance, and outlook across three key areas:
Market Volatility and Potential Returns: An analysis of recent market dynamics, our strategic positioning, and the substantial returns we anticipate as markets recover.
Hedge Performance and Risk Management: A transparent look at our hedging strategy's effectiveness during recent turbulence, lessons learned, and our approach moving forward.
Monetary Policy and Market Implications: An examination of recent policy developments in the U.S. and Japan, and how these align with our investment thesis and portfolio positioning.
Key highlights include:
Potential for nearly 58% portfolio gain as assets recover to recent highs
Effective hedge performance during market downturn, providing over 2% gain on a significantly negative market day
Strategic positioning in semiconductors, poised to benefit from strong AI demand
Clarification of U.S. labor market data supporting our bullish stance
Bank of Japan's measured approach creating a supportive environment for our Japanese holdings
We invite you to read on for a detailed discussion of these points and more. For prospective investors, we believe this newsletter presents a compelling case for partnering with us at this critical juncture. For our current investors, we hope this communication reinforces your confidence in our strategy and outlook.
I. Market Volatility and Potential Returns
The market has experienced heightened volatility over the past few weeks, leading to a pullback from the year-to-date highs we witnessed in July. While this has impacted our portfolio in the short term, we believe this volatility is temporary, and we're already seeing signs that the worst may be behind us.
During this period, we've adhered to our core strategy of identifying value and capitalizing on market inefficiencies by:
Buying on dips in high-conviction positions
Establishing new positions in assets we believe are undervalued
Continuously seeking the market bottom to maximize future returns
While this strategy may result in some paper losses in the immediate term, it positions us extraordinarily well for the recovery we anticipate in the coming months.
Our analysis suggests that if our holdings simply recapture their year-to-date highs—most of which were achieved quite recently—we stand to see significant gains across various asset categories:
Cryptocurrencies: Potential to add over 9% to our portfolio
Semiconductors: Poised to contribute more than 14% in gains
Software (Small Caps): Expected to add nearly 16% to our returns
Big Tech: While more stable, still offering over 2% in potential gains
Cybersecurity: Set to contribute almost 5% to our portfolio
Chinese equities: Presenting opportunities for nearly 6% in additional returns
Other categories (including Japan AI, Regional Banks, and Defense): Collectively offering over 6% in potential gains
In total, we're looking at the potential for our portfolio to gain nearly 58% as these assets recover to their recent highs.
We believe we're at a critical juncture that presents a compelling opportunity for both current and prospective investors:
Rapid Recovery Potential: Just as volatility can lead to quick downturns, the subsequent upswings can be equally violent and swift. We're positioned to capture these gains as the market recovers.
Asymmetric Risk-Reward: Our current positions, acquired at attractive valuations during this pullback, offer significant upside potential with comparatively limited downside risk.
Diversified Exposure: Our portfolio spans multiple high-growth sectors, providing balanced exposure to some of the most dynamic areas of the global economy.
Proven Strategy: Our approach of buying during dips and establishing positions in undervalued assets has consistently delivered strong returns over time.
II. Hedge Performance and Risk Management
Our hedging strategy has played a crucial role in our risk management approach during recent market turbulence. During a recent market downturn, when Japanese markets experienced a significant 12% decline and US markets fell 3-4% (depending on the index), our portfolio actually gained over 2%. This performance underscores the value of our risk management approach in protecting capital during extreme market events.
In retrospect, there was an opportunity to lock in profits from our hedge position, which could have added approximately 8% to our fund's performance. However, given the ongoing geopolitical instability, particularly the potential for conflict involving Iran and Israel, we made the decision to maintain our hedge.
As the market stabilized in the following days, our hedge position naturally declined, which was disappointing but not unexpected given its design as a protective measure rather than a primary return driver.
This experience has reinforced a key lesson: we must be prepared to act decisively to lock in gains from our hedge positions during extreme market events. Going forward, we will stand ready to liquidate hedge positions during future spikes, which we anticipate will occur periodically.
Looking ahead, we expect volatility to remain elevated in the medium term, particularly given the uncertainty surrounding the upcoming US elections over the next three months. This environment underscores the continued importance of our hedging strategy.
Despite recent market challenges, we are only a few percentage points down for the year. Moreover, our hedging strategy provides a robust floor for our portfolio. In a worst-case scenario, we have confidence that this floor will keep us at current levels, if not a few percentage points higher.
III. Monetary Policy and Market Dynamics
Recent developments in monetary policy, both in the United States and Japan, have significant implications for our portfolio and the broader market outlook.
United States: Labor Market and Federal Reserve Policy
The recent volatility in U.S. markets was partly triggered by unexpected labor market data. July's jobs report showed a significant shortfall, with only 114,000 new jobs added compared to the expected 175,000. This discrepancy was largely due to idiosyncratic factors such as hurricanes in the South and temporary layoffs related to strikes.
This report initially caused concern that the Federal Reserve might be behind in its rate-cutting cycle, leading to a market downturn that particularly affected our semiconductor holdings. However, subsequent data, including the Thursday weekly jobless claims, has indicated that July's report was likely an aberration.
As the market recalibrates its expectations, we anticipate a potential "liftoff" in asset prices, particularly in the semiconductor sector. This view is further supported by recent industry data, such as TSMC (the world's largest semiconductor manufacturer) reporting a 45% increase in revenue for July, indicating stronger-than-expected demand for AI-related chips.
Our strategy of quietly building and, in some cases, establishing new positions in the semiconductor sector during the recent three-week downturn has positioned us to capitalize on this potential upswing.
Japan: Bank of Japan's Measured Approach
In Japan, despite the Bank of Japan (BOJ) increasing rates for the first time in over a decade, recent communications from the central bank have helped stabilize market sentiment. On Tuesday, the BOJ clarified its commitment to ensuring market functionality, alleviating concerns about an irreversible hawkish tilt in monetary policy.
This measured approach by the BOJ is likely to support a reversal of the recent losses in our Japanese positions, contributing to the overall recovery we anticipate in our portfolio.
Implications for Our Portfolio
These monetary policy developments in both the U.S. and Japan align well with our investment thesis and current positioning:
In the U.S., the clarification of labor market data supports our bullish stance on the semiconductor sector, where we have strategically increased our exposure.
In Japan, the BOJ's balanced communication is likely to provide a supportive environment for our positions, potentially accelerating the recovery of recent losses.
Overall, these factors contribute to our confidence in the potential for significant near-term gains across our portfolio, particularly in our technology and Japanese holdings.
Closing Thoughts
While the recent market volatility has presented challenges, it's important to remember that none of our paper losses have been realized. Instead, we've used this period to strengthen our positions and set the stage for potentially outsized returns.
We anticipate that as the market stabilizes and begins to rally, even modestly, our portfolio is poised to deliver exceptional performance. The potential to gain over 50% by simply recapturing recent highs underscores the significant opportunity before us.
For those considering increasing their investment or for new investors looking to partner with us, we believe this is an optimal moment to act. The combination of our strategic positioning, the diverse array of high-potential assets in our portfolio, and the anticipated market recovery presents a unique opportunity for substantial returns in the coming months.
We remain committed to our disciplined investment approach and are excited about the prospects ahead. As always, we're available to discuss our strategy and outlook in more detail.
Thank you for your continued trust and partnership.
Sincerely,
Pranjit K. Kalita
CIO
Birkoa