July Review

Portfolio Update

There were no changes to the portfolio during July.

Performance Review
After positive performance on each of the first 8 trading days of July had safely ensconced the book well into positive territory, the portfolio bounced around to ultimately end near the mid-point between its intra-month high and low.  The result was a strong July, with the portfolio finishing +1.4% for the month bringing the year-to-date performance (-0.1%) to the brink of flat.

With all the words spent discussing US default as the debt-ceiling debate intensified into month-end, it would be reasonable to think that the L Treasury Bonds book would have suffered.  This thought would have been mistaken, as the book drove performance (+159bps) largely on the back of a seemingly continual stream of disappointing economic data.  The Bond Funds book (+42bps) also contributed strongly.

The Equity books were somewhat disappointing.  The NCAV book (+2bps), which has underperformed so far this year, largely weathered the storm while the limited size of the Short China (-1bp) and Energy Efficiency (-1bp) books meaning that they had no real impact on the portfolio.  Disappointingly, both the Other Equities (-17bps) and the Put/Hedges (-13bps) books suffered more than might have been expected, with the Silver puts largely responsible for the latter’s performance.  The Value Equity book (-37bps) was again the worst performing book, with both positions suffering from their longer-term thesis as risk aversion increased.  While we remain in a risk-off period both THRX and DRWI are likely to continue their struggles in the coming months, with neither likely to have a major catalyst till late-2011/early-2012.  Given their limited size in the portfolio, while the volatility makes for uncomfortable month-to-month performance, it is a risk that the portfolio can comfortably underwrite and there are likely to be opportunities to add to both names at attractive prices in the days and weeks ahead.

The portfolio’s Currency exposure (+4bps) was positive, despite the latest European bailout.  My opinion is largely unchanged; today’s situation bears a certain analogue to the failure of Credit-Anstalt (in 1931) and the dominoes that subsequently toppled due to the poor handling of the issues of the day.  I believe that we are continuing to witness the slow-motion toppling of dominoes, resulting from too much debt (i.e. debt beyond a level that can realistically expect to be repaid).  It was started by the US subprime crisis but has now spread its epicenter to European sovereigns fanned by a global unwillingness to accept failure (especially of banks), to force bondholders to accept their investment risk (i.e. default), and a refusal to treat the source of the crisis (too much debt which means more debt is not the solution) rather than the symptoms (liquidity issues).  Europe’s single currency experiment (removing the option of devaluation, for the weak) and its bureaucratic structure are amongst the reasons that the ricochet has bounced there first. 

Portfolio (as at 6/30 - all delta and leverage adjusted, as appropriate)
36.9% - Treasury Bonds (Aug-29 Bond & TLT, and 76bps premium in TBT Jan-13 puts)
22.1% - Bond Funds (VBIIX, DLTNX and HSTRX)
5.0% - Value Idea Equities (THRX, and DRWI)
3.0% - NCAV Equities
2.4% - Other Equities (NWS, CMTL and SOAP)

0.3% - Energy Efficiency (AXPW)

<-0.1% - China-Related Thesis (6bps premium in FCX put)
-1.1% - Hedges/Put Options (14bps premium in S&P Dec-11 puts, 17bps in IWM Jan-12 puts, and 17bps SLV Jan-12 puts)

-6.7% - Currencies (EUO – Short Euro)

28.0% - Cash

Disclaimer:  For added clarity, Our Man is invested in all of the securities mentioned (Aug-29 Treasury Bond, TLT, TBT puts, VBIIX, DLTNX, HSTRX, THRX, DRWI, NWS, CMTL, SOAP, AXPW, FCX puts, SPY puts, IWM puts, SLV puts and EUO).  He also holds some cash.