Passport Special Opportunities, a fund of Passport Capital, LLC the +$4 billion San Francisco based, global investment firm founded by John H. Burbank declined -9.8% net versus +1.2% for the MSCI AC World Index and +2.5% for the S&P 500 for the second quarter. This loss takes the Passport Special Opportunities loss over the past 12 months to -14.4%, according to a letter to investors obtained by ValueWalk.
Over the long-term Passport Special Opportunities has produced a relatively attractive return for investors. Since inception in May 2008, the Fund has compounded at 10.0% net on an annualized basis. Over the same period, the MSCI AC World has compounded at 3.3% and the S&P 500 at 7.5%.
For the quarter, equity longs detracted approximately -0.4% gross, and shorts detracted approximately -9.8% on a gross basis. Non-equity investments contributed approximately 1.4% on a gross.
Passport Capital: A warning
Passport’s second quarter letter to investors strikes a downbeat note.
Over the past 18 months, the fund has become skeptical about growth and cognizant of broad deflationary pressures. Further, Passport’s team feels “strongly that the level of Central Bank influence on markets holds the potential for a broad range of both intended and unintended consequences, which may well run contrary to true fundamental economic and corporate realities.”
The letter continues:
“Consequently, in our view, levels of equity market indices seem to reflect benign attitudes toward risk and faith that Central Banks will be ready and willing with an effective round of easing for all and any macroeconomic headwinds, as witnessed most recently by the rally back to the highs only days after the largely unanticipated “Brexit” decision in the U.K. We believe an exogenous growth shock, indeed one that carries broad uncertainty, would have otherwise weighed on investor sentiment more significantly, but that market performance in the Brexit aftermath is illustrative of excess liquidity in markets.”
From a portfolio positioning perspective, these developments mean that Passport is now looking to reduce its exposure to “those sectors that could be largely impacted by U.S. dollar sentiment ranging from Emerging Markets, to Commodities, Industrials and Mining”. Why these sectors in particular?: “facing poor fundamentals with stocks trading at high valuations, we think these sectors could be “vulnerable” to “risk-on” market moves driven by excess liquidity.”
Passport is also extremely negative on the outlook for the US economy. Specifically, the fund states:
“We have encountered increasing evidence of cyclical slowing in the U.S. economy. Broadly recognized sluggishness in business investment and reluctance of companies to invest in R&D have contributed to a slower pace of economic expansion. In June, U.S. corporate capital expenditure plans fell to the lowest level registered on the index since 2012, and this survey data was completed prior to the uncertainty introduced by the Brexit vote. Restaurants, which we view as an early window into the health of the consumer, have begun to display weak comparable store sales trends, though this is largely missed by consensus due to the timing of company reporting dates. Additionally in the retail arena, U.S. real luxury goods spending turned negative year over year at -2.7% as of May 2016. Auto sales are another key economic variable that we track closely, and we have found that the auto cycle has in the past led the unemployment cycle. We believe that auto sales have peaked and that loose underwriting standards have pulled forward future demand, which will drive further headwinds to auto sales when the credit cycle turns.”
Passport is looking to play these key trends with gold. The fund’s main investment class is gold, in particular gold miner stocks with high free cash flow yields, cost structures denominated in commodity currencies, and compelling idiosyncratic upside potential. Detour Gold would seem to be Passport’s top pick here with 19% of assets under management devoted to this one miner.
The other key trend the fund is playing is the rise of the Chinese consumer and China’s rapidly expanding internet industry:
“This year, especially, it has become clearer to us that China has reasonable medium-term control over its macro destiny, and we expect consumption, and particularly demand for dominant internet services, to grow steadily. For context, China’s per capita household consumption is similar to what it was in the U.S. around 1970, which then proceeded to grow at a CAGR of 9% for the next 10 years, 8% for the next 20, and 6% for the next 40”
Tencent Holdings (11% of NAV) and Yahoo! Inc (9% of NAV as a way to own Alibaba Group) are the two key holdings Passport is using to play this theme.
See a big excerpt from the letter below
Passport Special Opportunities – Portfolio Construction
Our portfolio construction leading into the second half of the year is very much driven by strong thematic perspective informed by our late-cycle macroeconomic views and in which we have high conviction:
- We are negative on Consumer Discretionary given our view on early signs of U.S. consumer weakness. We are also negative on certain agricultural commodities markets which we view as plagued by oversupply resulting in cash flow problems for producers.
- We believe that the current focus of Central Banks on providing constant stimulus and liquidity to financial markets continues to provide a very constructive environment for gold and gold equities.
- Despite being somewhat cautious on the outlook for the Chinese economy and financial system broadly, we remain very positive about the outlook for Chinese consumption and especially for leading Chinese internet businesses.
- We have identified several opportunities in industries where we think demand drivers are stable and returns can be driven by corporate change and consolidation rather than relying on broader GDP growth.
- We believe that the government of Saudi Arabia is truly committed to substantial market and economic reforms. Given our long experience and understanding of Saudi Arabia we are again excited about the alpha potential here.
Our thematic insights, added to our fundamental security selection process, give us confidence in our positioning and potential return profile, while we are mindful that what we believe to be ultimate economic reality and risk may not be fully reflected in financial asset prices in the short term.
We are also very cognizant of the well-researched but ignored dangers of equity markets in the immediate lead-up to a U.S. election. In election years without an incumbent there is evidence of spending pullbacks and deteriorating employment trends. Studies also show that during the 50 days prior to a presidential election, volatility tends to increase substantially, with commensurate declines in equity markets.
This year we have already witnessed periods of financial markets beginning to reflect