As assets continue to flee his hedge fund, John Burbank III looks for solutions. In a July 31 letter to investors reviewed by ValueWalk, nearly 63% of Passport Global’s assets under management, $480 million, walked out the door in the quarter, Passport’s Q2 Letter reveals. Burbank is stoic as a pair of portfolio managers and the firm’s president leave the firm, making strategy adjustments and looking to unique investing opportunities, some of which might be driven by the cryptocurrency craze.

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Passport's Q2 Letter

Passport's Q2 Letter goes back to basics, strategy up 1.6% in second quarter

Passport Global was up 1.6% in the second quarter while the S&P was up 3.1%. At least the fund is positive. Over the last year, Passport Global lost -16.8% while the S&P 500 advanced by 17.9%.

Investors have been fleeing with the negative performance. Since February 1, 2016 Passport Capital assets, spread over several strategies, fell from $4.5 billion to now rest near $900 million, according to the Passport's Q2 letter.

As he looks at what went wrong in Passport's Q2 letter, Burbank decided to go back to portfolio management basics, which is what he credits for the second quarter gain.

The fund has a laser “focus on what has historically differentiated Passport’s investment approach,” one that considered “broad macro themes and secular change” that translated into “rigorous stock selection.” This has resulted in a portfolio with lower gross exposure ranges from 160% to 170% in the second quarter, featuring lower turnover, down from 150 to 70 individual stocks.

Given this reversion to the original portfolio management approach, Burbank is pleased:

We believe the adjustments outlined above have begun to bear fruit with our focus on longer duration, risk-managed positions. In particular, our anti-consensus Saudi liquidity catalyst has materialized with extra support given political changes, and our overall portfolio positioning—avoiding substantial short cycle macro bets and focusing on idiosyncratic and orthogonal themes—has proven to be advantageous. This has resulted in what we believe to be robust portfolio positioning, built for duration, with the ability to take rapid advantage of a change in the macro outlook when appropriate.

The fund still has a strong quantitative risk management focus it says “remains critical,” as they have begun to recognize the power of factor investing.

Passport's Q2 Letter

Passport's Q2 Letter  - Macro themes Burbank is watching: US policy surprises, dampening confidence, broken correlations

When looking at that macro focus that brought them fame and fortune – despite challenges over the past few years, since their founding in 2000 they generated an average annual rate of return of 13.6% -- they consider the usual suspects but also add unique a unique twist.

The fund as reduced exposure to “US policy dependent exposure” as “surprises,” particularly relative to correlations between the US dollar, gold and oil, may diverge from the norm.

After widespread election market hope, a fading of excitement is being witnessed not only anecdotally but also in terms of sinking University of Michigan Consumer Confidence numbers, now at their lowest since the US presidential election. The anemic bond market drips with a lack of enthusiasm as Burbank thinks “dollar weakness could easily persist,” drawing a contrast to some analysts to expect the currency to move higher.

“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,” Burbank wrote. “We believe a weak-dollar environment could be good for commodities, but surprisingly the fundamentals of oil, in particular, have overwhelmed the weak dollar.”

Burbank, like many analysts, is concerned about the unwinding of the US Federal Reserve balance sheet, but does so with a twist. The Fed is about to take the baby step of gradually reducing the reinvestment of principal payments it receives, potentially lopping of a scant $10 billion in US Treasuries and mortgage-backed securities.

What might be more on the mind is not so much the immediate impact, but down the road considerations. “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),” he wrote, pointing to the potential for quantitative easing to turn negative in 2019, actually subtracting from GDP at that point rather than being positive by 2% at present.

Then there is China, the subject of much hedge fund speculation. Here Burbank observes what a managed economy looks like:

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. 

Passport's Q2 Letter : Invest in cryptocurrency and blockchain revolution through AMD

In terms of idiosyncratic portfolio position, Burbank considers the macro trend of cryptocurrencies and Blockchain technology and can’t ignore the collateral impact.

When an August 8 Goldman Sachs report stated that “it’s getting harder for institutional investors to ignore the rise of cryptocurrencies,” pointing to a $120 billion market. Burbank agrees. He isn’t investing in the currencies themselves, however.  He likes the plumbing play around the technology and in particular likes one chip stock over another:

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.

Specifically, Passport's Q2 letter states:

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

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