August Fund Performance
Bulls win, again
Hi Everyone,
See below quarter end fund performance data ranked by monthly performance.
HOUSEKEEPING
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Fixed Income
Fortlake coming back? Hard to push the pedal after a meaningful drawdown, might finally be there
Duration isn't rewarding (yet)
But makes me wonder, a normal inflation or deflationary scenario is almost completely priced out today, opportunity?
FI LITs
Tonnes of activity in this space today
New structures seemingly making it more palatable but also immensely profitable for the manager (who is the real winner?)
The chase for yield is rising, especially with base rates falling
Private Credit
I find it funny and sad that Metrics are copping it in the media and from ratings agencies on their governance.
Most players in the industry haven’t thought about governance to the level they have let alone have frameworks in place.
Long way to go for everyone.
I find also it surprising that ASIC have strong views on lack of disclosure in an industry without any agreed-upon standards. Obviously, there is no disclosure because no one is compelled to do so and the word “private” does have some weight.
Domestic Large Cap
Value firing up again
Some funds recovering now that CBA is taking a breaker
Longer term, it is still difficult to beat the benchmark
Where do you go overweight today? More having to go down to the midcaps or taking wild swings at things that sometimes don’t work (ahem, CSL)
The 1 yr lacklustre numbers from some funds here is largely due to CSL
Domestic Mid/Small Cap
Massive moves last month, largely dominated by who was long a number of specific stocks
TUA, 360, ZIP, goldies and lithium driving much of the performance
You can tell who was underweight these themes
That month saved a few funds from underperforming the index over 1 and 3 years!
Domestic Micro-Cap
Been my favourite index over the last 18 months, so many funds have closed shop with less than a handful new ones
Capital activity (M&A, cap raises, IPOs) exists in this space for those that are worthy
And because the hurdle (ie cost of capital) is so high, good companies are being rewarded well
International Equities
Caledonia performance bouncing but doesn't go astray to mention they've generated -1.9%pa over 5 years
Growth names took a breather after a wild 12 months
Value and small caps delivering while a lot of MSCI ex-Mag7 lagged
Lots of active management tilting away from US & Mag7 exposure, but who is right?
Concerns about concentration in the index yet the ASX200 has shown us high levels of concentration can persist for decades
Infra + REITS
Need to take a view on the "risk free" cost of capital here
Short rates coming down (helps financing) but long rates (influences cap rates) have now normalised
Public vs private
I'm keener on the private space today rather than listed markets, board led divestures and redemptions in various vehicles creating opportunities that have not been priced appropriately
I'm yet to find a listed vehicle to provide this exposure effectively
Other
LS funds getting a breather finally with CBA selling off
Massively different outcomes between the various CTA funds. From AQR +19% to Aspect at -15%
Pet rock dominates.
I highly recommend buying a small gold bar just to touch it, it’s a fun thing to hold
Gold price translating into earnings, GDX finally showing convexity to rising gold prices.
GDX doesn't look extended.
Terra the only fund that has beaten Gold $ over a year
GICS Sectors
CSL smashing the healthcare sector and setting a bad precedent for flows
Anyone want to make a comment on when earnings bounce back?
Discretionary still fascinates me
You hear about how tough Aussies are doing but looking purely at numbers (GDP, UE, Inflation, discretionary earnings) Australia is booming
Bonus Round
Who buys Bitcoin
Over-40s have a bias towards gold
Under-40s have a bias towards BTC
It’s the same trade either way that potentially protects you against various sovereign and currency issues.
Supply dynamics are better for BTC but demand dynamics better for gold (for now)
Still around 10x until Bitcoin flips the market cap of gold
Thoughts of the month
Totally addicted to FCF
I remember the Facebook earnings call in October 2022 where their operating margins dropped to 20% and they almost zero’ed their FCF on the back of crazy hiring and the metaverse pivot (lol). Stock was already down tonnes then tanked post-earnings.
Markets drew a red line, all this spending with no reward, to which Zuck responded by controlling costs. FCF rose dramatically and the market absolutely loved it. Headcount control became the name of the game. Cost discipline was suddenly sexy.
And higher earnings x higher multiples = higher share prices.
META FCF (LHS) vs Share Price (RHS)
Ooft, good stuff right there.
All of a sudden, those negative cash flow stories or burn for growth narratives all turned it on full blast.
UBER FCF (LHS) vs Share Price (RHS)
Uber is probably the ultimate poster boy for this playbook. They used the negative rate environment to build a business moat that competitors simply cannot approach, then flipped the switch to profitability when rates turned. Check out the share price rally once the last negative quarter was cycled out (31 Dec 2022).
Companies replied to a high cost of capital when markets thought they never could. The dopamine hit was formed.
Totally addicted to cashflow
Markets rewarded financial discipline, those expanding multiples combined with growth equals stocks mooning.
But you’ll note above that META FCF is falling again which is completely on the back of massive Capex spend around AI. And many ask, rightly so what about the returns on this capex as we’ve already been burnt once. So rather than excitement, there's more fear than anything else. People inevitably are calling this a bubble. Where is the killer app? When does this capex turn into profit?
Return on Investment
AI folk will have you know that jobs will be replaced. And everyone keeps questioning exactly who will be replaced? Doctors? Engineers? Accountants? CFOs? CEOs?
But tech c-suite got that dopamine hit in 2022, and they will do what they know best.
They want free cash flow.
They're totally and completely addicted to it. If you want a clear and simple answer to what all this AI capex spend is going to target: tech margins.
After capex, headcount represents the biggest expenditure line item for these companies. If you can replace the average worker who comes with the pressures of management, rising wages and all the other associated human complexities, by empowering a smaller number of workers to deliver the same level of output, the prize at the end is enormous. These companies already pay some of the highest average salaries in the world. If AI can maintain productivity levels with meaningfully reduced headcount, the margin expansion potential is staggering.
The AI Capex spend is effectively a buyback mechanism for remaining employees at the Mag7, higher profits shared among a smaller pool of workers.
(ChatGPT GPT‑5-Codex which is their agentic coding tool just dropped and its utterly friggin wild)
An Uncomfortable Conversation
My thesis for all this capex spend is purely higher Mag-7 earnings. This is a view I'm incredibly uncomfortable writing, particularly given how far markets have already run.
But the above thesis is not about controlling downside risk but rather thinking about answering that “AI killer app” and ROI question while also aligning ideas about getting convex exposure to AI in public markets. What if earnings keep rising? Who are the winners here?
Zero Lower Bound? Zero Upper Bound?
One of the more fascinating people I've had the pleasure of working with recently is Dr Keith Suter. Interesting chap with a wild thesis about a "Digital Geopolitical Order."
His argument is today’s roughly-200 nation-states and international organisations with defined borders and rules are being displaced. We are now entering a phase where mega corporations are more economically powerful than many sovereigns and the platforms & corporations that run the world (eg Mag-7) accumulate unprecedented influence. Apple, for example, has more turnover than half the UN member nations.
So very simply, over time, corporates will effectively have greater leadership and influence than governments. Power migrates from the public sector to the private.
Makes me think that everyone keeps talking about the shift in reserve currency.
Instead, this is a shift in where the reserve power lies.
In my view this shift in power is like the Catholic Church being more influential around the world than governments.
You can see the influence of major corporates in our lives today. In your pocket or in your hand right now is an Android or an iPhone, so you're forever stuck in either the Google or Apple ecosystem. Both have power (and responsibility?) through the sheer number of individuals they touch through their platforms. Same story with AI where the Mag7 have direct or indirect ownership of all the leading-edge models.
The Capital Management Divide
Corporates are profit-seeking institutions that know how to manage capital and are typically well-governed. Governments are well-governed too (or at least half the country thinks so at any given point in time), but they've clearly shown an inability to manage capital effectively. Poor fiscal control has led to outsized budgets and mounting debt burdens.
There's been a lot of leeway given to governments regarding spending and debt issuance (developed markets have not seen the consequences in generations), but over the last few years, we've witnessed two major events where markets clearly drew a red line. The Liz Truss debacle in 2022 and the recent Trump bond market dummy spit this year. Both events saw bond markets lose faith in fiscal responsibility.
Developed markets have been pushing the boundaries of what can be achieved and are now trapped in coffin corner. There's no reasonable outcome here in my view.
The Impossible Choice
(some of) The choices are stark: inflate your way out (which kills the consumer), cut spending (but you gotta keep the lights on!) or default. I have no idea which way it goes, but we know the destination(s) if not the path.
Bond yields are normalised today relative to the last 30 years, the aberration that was 08-22 was NOT NORMAL. We’re back to normality now.
And I’ll even go as far to say, that US10YR bond yields aren’t really pricing in anything other than business as usual today. Rates are being cut to bring policy setting back down to normal, whatever that is. And the longer-dated stuff (10yr+ US Treasuries) is reflective of demand for bonds with yields sometimes pricing in chaos when someone says something silly.
There is so much commentary about rising yields, but the reality is that bond yields have actually been fairly stable for some time now and bond market volatility is falling.
There is arguably no premium for any sovereign debt issues in US bond markets today.
Directionally, I take the view the risk premium for sovereign debt will continue to increase. One of those things again where I am unsure of the path but surer about the destination.
Who’s the real money maker?
While the rising risk premia for sovereign debt rises, the Mag-7 (and other quality businesses) continue to absolutely print cash money. These companies have fortress balance sheets, predictable cash flows, and dominant market positions. Which brings me to a provocative question: how long before we see negative credit spreads for corporate credit?
It's a weird implication but a genuine possibility.
(I'll take a moment here to acknowledge swap spreads make this mechanically untrue in a pure sense, but I can't help but explore this because of how sensational it sounds.)
The Unthinkable Becomes Thinkable
On the jagged edge of this logic, do Apple bonds trade below USTs? Sure, why not! How long before we see a <SOFR +5bpsbps> raise? What about a -50bps raise? It sounds absolutely absurd, but we're living in interesting times.
My wild idea is that negative spreads could potentially be the negative bond yields of this cycle. Think about it, if you believe Apple is more creditworthy than the US Treasury, why wouldn't you demand a lower yield for lending to Apple?
The mechanics would be fascinating. Corporate treasurers issuing debt at (or even below!) sovereign benchmarks while governments pay ever-higher premiums for fiscal profligacy (shift-F7 working overtime here). It would represent a complete inversion of the traditional credit hierarchy.
Silly thinking but seeing corporates trade inside treasuries persistently in the US is possible.
The Deflationary Wild Card
I’ve also been thinking about the other tail outcome, the deflationary angle.
What about deflation brought about by productivity improvements from AI and an aging population? If we're heading into a sustained deflationary environment (which I’d argue isn’t priced in at all), the companies driving that productivity revolution (our beloved Mag-7) would be the ultimate beneficiaries.
Deflation rewards creditors and punishes debtors. Guess who the biggest debtor is? Governments. Guess who's sitting on massive cash piles and generating enormous free cash flows? The corporates that could theoretically fund themselves more cheaply than sovereigns!
Either way, this is an incredibly painful outcome for government balance sheets. Especially if we start doing yield control and helicopter money again.
As an aside, if we end up deflationary, a way of expressing this view is long bonds (20yrs+) which have awesome convexity in that outcome. Don’t discount it.
Thanks
Well done for making it this far and it pleases me you are reading this sentence. I thank you for reading the above and I hope it has provoked some thoughts.
Cracking thoughts of the month Mr Quick. The deflationary wildcard seems more likely now that I realise it would be in the interests of the corporate oligarchs