Vltava Fund commentary for the first quarter ended March 31, 2017; titled, “A Bit About Trump, A Bit About The Koruna.”

2017 Hedge Fund Letters

Dear shareholders,

In the first quarter of 2017, the Vltava Fund’s NAV declined by 0.9 %.

No political event has divided people as sharply as the US presidential election in November, and therefore we return to it once again. President Trump has rather dramatically distinctive opinions on a number of issues. I must say that I like some and dislike others, and I am curious as to both how he is going to maintain them and how he will manage to put them into practice. It is still too early to draw any conclusions. I would not like to be as hasty as was the Nobel Prize committee, which honoured Obama practically before he even was inaugurated. Instead, I would like to consider what impacts Trump and his policies may have on developments in the investment environment and investing generally. Every investor must weigh this carefully and should be mindful not to let his or her political preferences influence expectations for the market developments. We ourselves try to maintain a rather agnostic approach, taking things as they are. I would divide considerations as to the possible impacts of Trump’s presidency on markets into two parts. Regarding the first part, I will try to outline more generally what change in investors’ thinking may occur, and regarding the second I will focus on certain specific steps being prepared by the Trump administration.

Vltava Fund

Waking the entrepreneurial spirit

Over the past eight years we have witnessed on both sides of the Atlantic a considerable shift to the left with numerous elements of socialism, a strengthening in the role of the state, unbelievable expansion of regulation of everything possible (and even some things unimaginable), establishment of subtle obstacles to the private sphere, and further alienation of the ruling elites from the common people. In such an environment, businesspeople naturally feel like outcasts living at the edges of society, guilty in their capitalist thoughts. In the Czech Republic, entrepreneurs are labelled parasites and many wake up at night in terror of what the state will think of next. The fact that our country is no exception is only small consolation.

Enter Donald Trump. In the first days after his inauguration, Trump held several meetings with top businesspeople in the US. As compared to Obama, who, as a proper leftist intellectual, was always a little disdainful of the private sector, this represented a complete U-turn. I am certainly no leftist, and definitely not an intellectual. By process of elimination, I suppose that makes me a right-wing savage. And from my right-wing savage worldview, I see the private sector as the driving force of progress and of the creation of wealth in society, whereas the state is a brake on both progress and wealth creation.

If Trump’s relationship with American business is an indication that the private sector will cease to be seen as parasitic and instead as the state’s driving engine and provider, and if the state limits its interference therein to a bare minimum, this could have a great impact on people’s thinking. The entire entrepreneurial paradigm may shift and waken people’s slumbering entrepreneurial spirit. And that spirit, by the way, may be the most precious thing we have.

Investment implications

The above reasoning is not self-serving. The development as described may have dramatic impacts on the investment environment and on the valuation of various asset classes. Let me demonstrate this while taking bonds as an example.

We are living today in a time of historically low interest rates. The simplest explanation is to attribute this to consequences of the Great Financial Crisis nine years ago, but what if it were more complicated than that? Interest rates have actually been decreasing for more than 30 years. I believe this may be the result of a sense of insecurity among people. I would venture one step further and say that this insecurity is cultivated by governments. If the state manages to convince people that the future is very uncertain (as if it has ever been or could be otherwise) and that a stronger, more powerful state is the salvation, then the ruling elite will have free rein to further strengthen its own power and restrict the liberties of the common people. In my opinion, that is exactly what has been happening in the developed world for at least the past 15 years.

A problem is that people who believe such fabricated paradigms and schemes behave accordingly also in their private lives, and that includes in how they invest. The phenomenon seen most frequently is a propensity for excessive caution. People prefer investments which they believe bear minimal risk, almost with no regard to their prices. In so doing, they in fact unknowingly undertake enormous risk.

Last summer after the UK referendum, when interest rates reached record-breaking low levels, there existed globally more than $13 trillion worth of bonds yielding negative rates of interest. Why do investors buy these bonds for such absurd prices? It cannot be due to their returns, which are negative. Could it be for capital gains? Hardly. The cause may lie in the distorted ideas forced upon them by others. The worst thing is that such investments bear high risk. For me, the culmination of the absurdity currently prevalent on markets could be seen in last year’s issuance of Austrian government bonds with 70-year maturity and a 1.5% annual coupon. It is very probable that such investment will bear a negative (possibly greatly negative) real yield for a period nearly equal in length to a human lifetime. Is that what a safe and conservative investment should look like?

Now, imagine that the paradigm shift described above comes about under such conditions. The state’s rhetoric will change. People will no longer be brainwashed regarding future uncertainties and the necessity for a strong state. On the contrary, the state will support enterprise and people’s entrepreneurship, their entrepreneurial spirit will awaken, and they will gladly and more willingly take responsibility for their own futures. Perhaps it is my wishful thinking, but such developments really could come to be. The Brussels elite’s horror over Trump’s victory shows that these people also understand this and feel themselves existentially threatened.

If common people develop a different understanding of the world, their approach to investment may also change dramatically. Certain currently overpriced assets can be expected to go into an unforeseen and long-term price decline. One should be prepared for this and not be taken by surprise should this occur. I am thinking first and foremost here of bonds. Investors often debate whether equity markets are overpriced, but the dearness of stocks does not come close to rivalling the current expensiveness of bonds.

Regulation

Let us now look at certain steps that the new administration is preparing. The first, and probably least controversial, is a reduction in regulation. Everything is regulated these days. More and more regulations are introduced practically every day. There are so many regulatory directives and standards that it is impossible to keep up, and these often even contradict one another. Taken together, they constitute an immense barrier to

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