Back in April, we reported that the Long-Short Strategy Fund of John Burbank, one of the handful of investors who made a killing from shorting subprime, and head of what was at the time the $2.4 billion Passport Capital, was shutting down after a series of negative returns: according to HSBC, the fund – which had an AUM of $636 million as of March – had lost 2.1% in the first two months of this year and was down 11.8% in 2016. As we further reported, a catalyst for the closure appears to have been the January 2017 decision by the San Bernardino employees fund to pull its funds from Passport.
Fast forward to today, when in his latest letter to investors, Burbank reports that at what was once a multi-billion fund, total firm assets at Passport Capital have as of June 30 shrunk to just $900 million as a result of net outflows (not including the Long Short hedge fund strategy liquidation, effective 4/30/2017) which totaled a whopping $565 million, or a nearly 40% loss of AUM due to redemptions.
Worse, Burbank also reports that his flagship Passport Global fund has been virtually wiped out, and following $480 million of outflows, or a stunning 63% in assets under management, net of redemptions Fund assets as of June 30 stood at only $275 million, to wit:
Capital Flows: For the second quarter, the Fund had net outflows of $480 million. Firm-wide, net outflows (not including the Long Short hedge fund strategy liquidation, effective 4/30/2017) totaled approximately $565 million. At quarter-end, net of June 30th redemptions, Fund assets stood at $275 million and Firm assets totaled approximately $900 million.
That said, aside from these devastating capital outflows, Burbank marches on, and reports that the funds was up 1.6% in Q2 net of fees. Additionally, following the shuttering of the Long/Short fund, Burbank says that the firm’s new focus will be as follows: “Lower gross exposure: ranging between 160% and 170% for most of the quarter; Lower turnover; Lower number of holdings (halved since the first quarter, from 150 names to 70). Despite higher concentration, with risk diversification of the long book, lower gross exposure and maintenance of risk limits, we have maintained realized volatility at the low end of recent historic averages at approximately 11%, as well as low realized correlation with the broader equity market.”
Finally, here are some additional observations from Burbank in his latest letter. First, on Macro:
As mentioned, we intentionally reduced our directional macro bets and U.S. policy-dependent exposure which appears to be the right positioning, as this year has provided some surprises, most notably with regard to the USD, as well as its typical relationship with gold and oil. Contrary to expectations, the trade-weighted dollar index peaked on January 3rd and is now below its level immediately prior to the presidential election in November 2016. It is clear there has been very limited follow-through on pro-growth policies promised by the current administration, and as a consequence broad expectations, as measured by the Citi Economic Surprise Index, peaked in mid-March and have dropped precipitously since then; it is now at a five-year low. The University of Michigan Consumer Confidence is also at its lowest levels since November 2016 (election month) and is in a downward trend. The bond market is reinforcing this view (yields lower/curve flatter). Even after the recent bounce following discussion of rate normalization, the 2/10yr remains at pre-election levels after almost reaching the post-crises lows set in August 2016.
Dollar weakness could easily persist; economic growth in many places around the world is faster than the U.S., and the $23 trillion of foreign capital invested in the U.S. post the financial crisis could be reversed triggered by faster growth and increased optimism.
We believe a weak-dollar environment could be good for commodities, but surprisingly the fundamentals of oil, in particular, have overwhelmed the weak dollar (this is consistent with our view on oil and represented in our neutral oil construct).
Further, core CPI inflation remains weak, and we believe the bond market is not yet convinced that the U.S. will sustain sufficient nominal demand growth momentum to push inflation sustainably back to the Fed’s 2% target. We are carefully monitoring discussions regarding the debt ceiling, given the Trump administration’s push for a debt limit increase before the August recess. In our opinion, if an agreement is not reached, the Treasury may use interest receipts held at the Fed (approximately $150 billion) to pay bills. Perversely, this could act as incremental fiscal stimulus—as it represents an injection of more cash into the market.
The potential consequences of Fed balance sheet normalization are also important. We understand the Fed intends to gradually reduce securities holdings by decreasing its reinvestment of the principal payments it receives, which would potentially reduce principal reinvestment by an aggregate of $10 billion per month (Treasuries & MBS) and would increase in steps of $10 billion at three-month intervals over 12 months until it reaches $50 billion per month.
Some estimates suggest that global quantitative easing (“QE”) will turn negative in 2019 after being consistently positive by about 2% of Global GDP in every year since 2011 (e.g., since 2007, the Fed’s balance sheet has increased by approximately $3.5 trillion). While it is believed this could result in a much steeper yield curve and tighter financial conditions, the Fed continues to give itself substantial policy leeway.
However, the consequences of balance sheet normalization may be limited, given that the pace of reduction will be much slower than the ramping up of QE, and some of the effects of balance sheet reduction are already priced in (the pace has been communicated). Balance sheet normalization could be offset by the Fed adopting an easier path for short-term interest rates than it otherwise would have chosen, and the Fed is going to be cautious out of concern that any decision to shrink the balance sheet might be seen as tightening monetary policy. Ironically, reducing the balance sheet could have a stimulating effect, by reducing excess reserves on deposit (which sit idle) and freeing up Treasuries which provide liquidity to the market. It will also potentially allow the collateral reuse rate to increase as balance sheet space on banks becomes more available. Although the Dodd-Frank Act and Basel accords make it more expensive for collateral to be reused, the increase in balance sheet space of the banking system may outweigh the regulatory cost.
Finally, our view on China has been that after the massive credit stimulus of 2016 that led to rapidly rising housing prices and rising levels of leverage and system risk, the Chinese government would tap the brakes with restrictions on housing and credit. This would be detrimental for commodity demand in the second half of 2017. In fact, so far this year the Chinese government has put a number of restrictions in place such as raising short-term lending rates and enacting housing regulations on a number of Tier 1 & 2 cities. However, the negative impact on industrial production, investment and commodity demand has not yet materialized, as the government has continued to inject credit into the economy via infrastructure and support for housing in Tier 3– 5 cities. Recent economic data has in fact been supportive of a continuation of strong growth near-term, with a slowdown possibly pushed to 2018. In its effort to crack down on shadow banking the authorities have encouraged a flow of capital into commodities given the limited number of investment options available to Chinese investors—which benefited commodity prices, particularly steel. We maintain a portfolio with a short tilt to Chinese IP, but we continue to monitor incremental data out of China that may impact our thesis and positioning.
… on Energy:
We remain bearish on oil. Currently the market is slightly undersupplied, with inventories peaking now but likely to decline sharply in Q4 and then flip into an oversupply during the first half of 2018.
OPEC, and its attempts to manage price higher, is frustrated by U.S. shale oil producers’ indifference to OPEC’s desire, and seems eager to hedge production in the high-$40s to lock in positive rates of return and mobilize rigs. We believe this dysfunctional dynamic is now appreciated by OPEC, putting future compliance at risk. The downside risk to price is a consequence of 1) robust U.S. production that we expect will inflect higher during the second half of this year, 2) sustained gains in Libyan and Nigerian production (not subject to OPEC compliance), and 3) increasingly poor compliance by OPEC members. The potential upside risk to prices stems from stronger than expected demand, disruption in supply (Venezuelan production, for instance, continues to drop), and U.S. underwhelming on production increase.
… and on AMD and Cryptos:
AMD has been executing in line with our expectations, with successful product launches across the PC, server, and graphics markets. Beyond its traditional markets, AMD is benefiting from an unexpected tailwind from the rising interest in cryptocurrencies, as its graphics cards are particularly well suited to the application of mining several cryptocurrencies. Recent market share studies also show AMD to be gaining meaningful share vs. Intel (over 5% in one quarter), and we expect those trends to continue, possibly even accelerate, in the server market. Based on these trends, our expectation is for AMD to generate earnings significantly ahead of sell-side estimates for 2018 and 2019.
We have been monitoring block chain technology and cryptocurrencies for some time. We believe this technology represents a secular change with the potential to profoundly disrupt many markets. AMD is the first position in the portfolio that has been a net beneficiary of this trend, but we expect our understanding of block chain technology’s potential to be an increasingly relevant factor in stock selection.
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