| John Burbank, Passport Capital (Bloomberg) |
John Burbank III’s Passport Global fund posted a hefty loss in the first quarter. And the fund — a combination macro and multistrategy fund managed by Burbank’s San Francisco–based Passport Capital — can heavily thank its equity book for the setback.
According to its first-quarter report, dated May 5 and obtained by Alpha, Passport Global lost 7.5 percent for the period. Nonequity strategies were actually profitable in the quarter, gaining 3.7 percent. Interest rate swaps returned 2.9 percent, and a short on crude oil added 0.9 percent. Although foreign exchange and volatility positions fell, they were off a mere 0.1 percent.
Passport Global’s equity positions, however, lost 10.5 percent in the quarter. Its short strategy is mostly to blame. It accounted for 9.6 percentage points of losses, while the longs declined by only 0.9 percent. All of these performance numbers are gross, meaning before accounting for management and performance fees.
Drilling further down shows short positions in the basic materials industry lost 5.7 percent, accounting for more than half of the short equity book’s losses. They were offset somewhat by 1.3 percent gains in basic materials longs. Industrial stocks were the other big losers in the short book, down 2.1 percent for the quarter.
At the end of the period, the fund had about $2 billion in assets. Altogether, Passport Capital had $4.1 billion. This is after suffering $70 million in net redemptions for the quarter. Passport Global had posted double-digit gains in three of the four previous years.
“Our overall positioning for well over a year has reflected serious concerns about the consequences of the ending of Quantitative Easing (QE) in the U.S.,” states the letter, signed by Burbank and Tony Fenner-Leitao, who handles marketing and investor relations. “Investment funds began 2016 either both informed and cautious of broad deflationary risks facing global markets, or oblivious and positioned poorly for them. We believed 2016 would mimic 2008 with widespread deleveraging into illiquid markets.”
The two executives say the fund began 2016 “defensively with liquidity.” This means it was long the U.S. dollar, the yen, rates and mostly U.S. large-cap stocks, and short risk assets it believed “would suffer as funds realized the extent of the market’s problems.”
Within three weeks into the year, with the markets reeling, the fund was “well-rewarded,” the report notes.
However, by the end of the quarter, it was obviously hurt, blaming this on “an extraordinary policy-induced rally,” even as earnings continued to decline. The letter is referring to moves made by central banks, especially in the U.S., and the Chinese government to “cushion financial markets” after the early-year market dive.
The letter elaborates that about the end of the third week of January, the U.S. dollar peaked and commodity prices started to find their bottom even though global growth fundamentals were continuing to deteriorate. “We later came to understand this was driven by actions from China, though no explicit policy moves had been announced,” Burbank and Fenner-Leitao assert.
Looking ahead, the two executives are upbeat. They say “substantial return opportunities” loom ahead. “We continue to believe that the U.S. dollar is the key macroeconomic variable driving risk appetite, and that it will resume its rise once markets embrace the fundamental truth of the consequences of divergent monetary policies,” they add.
Burbank and Fenner-Leitao note that the fund has a lower gross exposure, now at 176 percent, and a net exposure of just 18 percent. Its biggest net exposure among 12 broad sectors is to the Internet/technology industry; it is 28 percent long and 11 percent short this sector. By contrast, it is 14 percent short what the letter calls “diversified” companies, with no long positions.
Of the Internet/tech stocks, the letter singles out two for discussion. The firm likes Microsoft Corp., noting that its enormous $390 billion market capitalization “fits thematically with our bias for liquid, mega cap leaders.” Passport also plays up the stock’s 2.9 percent yield.
“New management is leading an exciting turnaround at Microsoft that is driving enthusiasm in engineering circles that are now just beginning to appear on the radar screen of investors,” the letter explains. “Furthermore, we believe that Microsoft is valued like an old tech company, while we believe things (mix, growth, culture) are getting better beneath the surface.”
Passport stresses that Microsoft’s cloud offering, Azure, “is a differentiated share-gainer second only to Amazon Web Services.” Burbank and his colleague also applaud Microsoft’s transition of Office, still its largest business, from a unit pricing model to a subscription model.
The Passport executives also single out Tencent, the Chinese social media giant. They say the company accounts for nearly half of China’s “very profitable and cash-generative online gaming market,” adding, “Chinese internet companies are the most compelling way to invest in China’s transition to a consumer-based economy.” Yet these stocks have lagged the rally in the U.S.
The letter also highlights fertilizer company CF Industries Holdings, noting it is currently involved in an expansion process that “has the potential to dramatically increase the earnings power of the company.”
