Portfolio Update
- Carbon Credits: OM has debated taking a position in carbon credits for a while but finally took the plunge at the start of the year with an initial position in KraneShares Global Carbon Strategy (KRBN). It has become clear with the Paris Accord & COP26 that the Western world (at least) is focused on carbon and has both set a target and timeline for its reduction. To achieve these would require aggressive moves; California and the EU are the leading proponents of and first movers in decarbonization and have large cap-and-trade carbon allowance programs. Unsurprisingly, the goal of these programs is to reduce carbon and hence both have created incentives for these carbon credits to increase in price over time. KRBN has ~90% of its capital invested in EU and California Carbon Allowance Futures.
- Commodities/Mining: The case for many commodities/mining can broadly be understood by reading any of OM’s pieces on Uranium or Tin. While OM believes these two commodities are the clearest examples of limited/constrained supply and increasing demand, many other commodities show a similar supply issues due to years of underinvestment and increasing demand. Ironically, the demand side is often impacted by the increased desire for ‘renewables’ or ‘electric vehicles’, which are vastly more commodity intensive than the fossil fuel alternative. OM began the theme with a position in Filo Mining (FLMMF), though the overall size of Commodities/Mining is likely to be limited while Uranium and Tin remain such significant positions.
- Energy: OM exited his position in Sandridge Energy (SD) during the first quarter. The company continues to perform, and almost tripled for OM. Energy displays many of the same traits as Commodities/Mining, and OM preferred to allocate his capital there.
- Short/Hedges: OM implemented a hedge for the first time in a long while; it seemed clear that inflation would lead to higher rates in the short-term with with various factors (including demographics) also suggesting the 40-year bull market in bonds could be over. OM has largely avoided expressing such views in the past due to the limited ways in which to execute them efficiently. This changed last year, after Harley Bassman and Simplify, launched the Simplify Interest Rate Hedge Strategy (PFIX). For simplicity, PFIX invests ~50% of its capital into a US Treasury Bond (5-year) and uses the balance to purchase put options at 4.25% on the 20-year rate, expiring in May 2028. In essence, with the value of the Treasury Bond providing a floor for PFIX should OM be wrong, the option provides substantial upside should long-term rates increase over the next seven years. (For the curious, or nerdy, page 7 shows the modeled profile)
Performance and Review
OM’s portfolio ended the first quarter +4.45%, after recovering from a terrible start to the year that saw it down over -12.5% for the year in the final week of January. While equity markets also rallied back from their lows, both the S&P 500 Total Return (-4.60%) and the MSCI World (-4.78%) ended the quarter in negative territory.
First Quarter Attribution
Given all of the above, it’s unsurprisingly that OM’s winners were largely from the commodity and hard asset related investments. The positions in Uranium (+411bps) led the way, as the case for nuclear power was further underlined as Europe’s reliance on Russian natural gas was made clear. The quarter saw both France and the UK commit to building more nuclear plants, the US discuss potentially banning Russian uranium and/or tax credits for nuclear power. OM’s other commodity positions – Tin (+136bps), Commodities (+36bps) and Energy (+44bps) – also contributed to performance. In particular, the positions in Alphamin Resources (Tin) and Filo Mining (Commodities) were good contributors after both reported positive results in their respective drilling programs.
Outside of direct commodity exposure, the other winners were also related to the key macro changes. The Shipping (+238bps) positions in oil and product tankers were direct meaningful beneficiaries of the conflict in Ukraine. Changes to the efficient flow of oil and its products, leads to extra seaborne miles of travel and higher utilization for the tanker fleets. This was most cogently demonstrated by Zoltan Pozsar (of CS) who noted that while it's easy to say China will buy Russian crude oil rather than Europe, in the real world just this change would use all the existing ships running the European route and tie up 10% of the VLCC tanker (the largest size of tanker) fleet! The Short/Hedge (+36bps) directly benefited from the rise in rates, which saw its embedded options become more valuable. The Idiosyncratic positions (+61bps) also aided performance; both Texas Pacific Land Trust (TPL) and St Joe Co (JOE) are real estate plays.
The detractors from the portfolio were equally unsurprising – growth stocks are long duration assets as their profits/cash flows occur well into the future. Unsurprisingly, as medium and long-term rates increase these cash flows are worth less today than they were previously. Three of the primary detractors were Blockchain (-164bps), Biotech (-104bps) and Tech-4th Industrial Revolution (-84bps) which all reflect this concept. The Funds book (-88bps) was driven by negative performance across the board. The negative performance from Vietnam (-42bps) and India (-31bps) in part reflected the geopolitics around countries believed to be in China/Russia’s orbit and the possibility of reduced globalization with supply chains moving nearer end customers and to friendlier countries. Finally, the position in Carbon (-24bps) was a detractor as there was some debate as to whether Europe would pause or waive its cap-and-trade allowance program due to the war in Ukraine. The position recovered most of its losses by quarter-end; decarbonization is quasi-religious in Europe/California and it will take more than a potential world war to slow it down.
The positions in Greece (+8bps) and Brazil (+12bps) weren’t material contributors, though Brazil – a commodity exporter – rose meaningfully in the quarter. After a tough couple of years and with an upcoming election and rates nearer a peak than trough, it’s a position that OM is spending a lot of time researching.
Portfolio (as at 03/31/22 - all delta and leverage adjusted, as appropriate)
Dislocations: 41.5%
27.4% - Uranium (URNM, CCJ, NXE, PALAF, DNN, BNNLF and URG)
10.2% - Shipping/Tankers (STNG, INSW, EURN, TNK and DHT)
3.8% - Greece (GREK & ALBKY)
Thematic: 39.1%
9.0% - Tin (AFMJF, MLXEF and SBWFF)
8.3% - Blockchain/Crypto (GBTC, ETHE, and OSTK)
6.2% - India (IBN, INDA and SMIN)
4.9% - Biotech: 4th Industrial Revolution (IBB & XLB)
3.2% - Tech: 4th Industrial Revolution (JD & WCLD)
3.2% - Vietnam (VNM)
2.1% - Carbon (KRBN)
1.7% - Commodities/Mining (FLMMF)
0.4% - Brazil (EWZ)
Technical: 0.0%
Idiosyncratic: 15.8%
10.5% - Funds (ARTTX, CWS, GVAL, and CAPE)
5.3% - Equities (TPL & JOE)
Shorts/Hedges: 2.6%
2.6% - Higher Medium-Term Rates (PFIX)
Cash: 1.0%
Disclaimer: Nothing above represents a recommendation in any way, shape or form so please don’t even think of trying to take it that way. For added clarity, while Our Man is invested in all of the securities mentioned that’s a terrible reason for anyone else to do so. Our Man also holds some cash and a few other securities (of negligible value). You should not buy any of these securities because Our Man has mentioned them, but should do your own work and decide what’s best for you given your own circumstances/risk tolerance/etc.
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