NF Macro Mid-Year 2020 Investment Update
I committed to publicly share my portfolio beginning June 1, 2020, but have been actively managing my portfolio since last fall when I launched NF Macro. Since this mid-year update is my first substantive note, it will cover more than just my decisions during the first half of 2020, but will also touch on my investment philosophy and allocations entering the year.
Investment Approach
First, a high-level note on my investment approach. I hesitate to call this an investment philosophy, because I am describing an approach that I find useful for identifying specific opportunities, not laying out a comprehensive set of principles.
My goal is to build an antifragile portfolio.
I seek downside protection with true diversification — not just the diversification found in index funds or stock/bond mixes, but a mix of positions I believe will hold up even in extreme and unprecedented outcomes. This means I am always looking for inexpensive “insurance” opportunities.
I seek outsized returns by occasionally making conventional value investments, and even more often, by buying cheap options.
In both of these, and in contrast with the growing quantitative focus of the finance world, I use mostly qualitative analysis. I focus on whether diversification and insurance efforts truly protect against severe losses, and look for scenarios in which certain options might have a highly positive payoff that the market is failing to adequately price. I often look at the world through themes that cross domains, drawing on concepts developed in one space to spot opportunities or risks in another.
One strong theme of my approach: I do not like to make predictions. Even when I take a large position, it usually reflects less a prediction of a particular outcome than a bet that the position offers an attractive return profile — either owing to low or negative correlation with other parts of my portfolio (reducing overall portfolio risk) or to inexpensive optionality. An exception is when I think I understand a reason the market is missing something and my prediction reflects a real information advantage. These are rare at the macro level but more common on private deals or alternative allocations where proprietary information plays a much larger role.
This does not mean I believe good predictions are impossible (though I think they’re far more difficult than many people assume). I just rarely believe I have a significant edge over the market in prediction, nor do I think my greatest skill is making such predictions. However, I will certainly back people I believe do have a predictive edge, though this should typically be seen more as a bet on them and/or their thinking on a trade rather than as an endorsement of their prediction.
Finally, a note on benchmarks: I will generally have a long bias, but will aim for strong, true diversification (that may include substantial cash positions) and will often employ hedges. I believe the best benchmark for my strategy is a 60/40 stock/bond mix. This is not perfect — an absolute return index may also be a good comparison — but the 60/40 index is a simple and well-known benchmark used by many real money mangers. I will often make decisions that put my portfolio at a slight disadvantage, such as choosing muni instead of taxable bonds or holding a stock that has gotten more expensive than I like to avoid realizing gains, but I don’t think these decisions are likely to substantially impede the 60/40 index’s value as a benchmark.
My investment approach reflects a personal way of thinking and working that I apply to business, societal, and political efforts — and to my own family and personal life. My goal of antifragility reflects my personal priorities and differs from many people’s stated goals, so I am uncertain how my performance will compare with typical investment strategies. I am certain my approach and performance will be differentiated from most in the market.
Portfolio Entering 2020
I entered the year with 39% of my portfolio in cash and another 12% in muni bonds. At the real estate company I co-founded in 2010, we liquidated a large share of our portfolio in the 15 months beginning October 2018. My large cash position was less an intentional allocation choice than a lack of enthusiasm for alternatives.
26% of my portfolio was in a few index ETFs and diversified mutual fund investments (American Funds — I was drawn to their manager, Capital Group, after reading about its model in Charles Ellis’s What it Takes). Most of my remaining equities were tech-related, not as a strong directional bet on tech but because of two specific themes I describe next.
Two companies, SHOP and SQ, together comprised almost 8% of my portfolio and appealed to me because of their focus on serving small businesses. I believe small entrepreneurs are underserved by both tech and financial services but will always be an important driver of wealth creation. Additionally, the space as a whole is antifragile to most shocks (even if individual small businesses often are not).
My biggest remaining equity bet was a position in Zillow and long-dated Zillow call options (together 3% of portfolio) based on Zillow’s potential to be a significant player in reshaping the US real estate market. As tech begins to transform this space, Zillow already has a dominant asset (its consumer site/app), solid team, and a strong founder/CEO with a significant personal stake in the company. There is no guarantee Zillow will come out a winner, but it is well positioned and this possibility offers massive asymmetric upside.
Two alternative allocations reflected strategies — and managers — I liked. REB (~3%) is an emerging market financials fund I chose for both value and geographic diversification. Delta Accumulation (~3%) is a long-volatility long-dated option strategy designed to offer positive carry, and was particularly attractive to me because of its potential for significant outperformance in a crisis (essentially very low cost insurance if the positive carry even outside crises proved real).
I had a small (~1%) crypto allocation, mostly Bitcoin and some privacy coins. I see these as doomsday options, and both may have meaningful advantages for certain use cases, especially in a time of growing political turmoil. I also see a possible scenario where Bitcoin becomes a significant store of value in many portfolios (potentially as another reserve currency/asset), which could have 10x+ upside in USD terms. I also had ~1% in a mid-sized gold miner, primarily as a 2–3x levered play on gold with some value pricing. I entered the year intending to increase both my gold and crypto exposure because of concerns about the USD as a store of value.
Finally, I entered the year with illiquid investments worth (at cost) about 8% of the value of my Liquid Portfolio (in line with my June note, these are not part of the Liquid Portfolio but I will disclose their performance separately when I get material updates). These included allocations to two venture funds (1517 Fund and Promonos — both with unique strategies in the venture space), a few angel/venture investments, and one controlling interest in a private company. The largest was an initial capital injection into Principal Investments, my new talent and small-business-focused investment platform.
First Half 2020 Retrospective
My Liquid Portfolio, which includes my liquid and liquid alternative investments and is the core portfolio I am tracking, substantially outperformed both the S&P 500 and the 60/40 index in the first half of the year. While the S&P 500 declined slightly and the 60/40 index was about flat, my Liquid Portfolio rose 28%.
This table summaries the performance of my Liquid Portfolio over the first half of the year, including the market’s peak (Feb 19, 2020) and the date I formally announced I was tracking my portfolio (month-end May 2020), and compares it with benchmarks:
This outperformance was driven by several factors. First is luck. My SHOP/SQ positions were intended to be a long-term bet on small entrepreneurs; in the post-COVID market they (along with other hot NASDAQ stocks) experienced rapid gains. I expected they would prove antifragile over the longer term, based on their strong business models and my small-business macro thesis, but post-crisis gains came faster than I anticipated. Though Zillow got hit harder in March, it also recovered rapidly and ended June at 25% above where it started the year.
Second, several “cheap insurance” trades paid off. My Delta Accumulation allocation more than doubled in the month following the market high, as I’d anticipated it would in a meltdown. Next, from Feb 19–24 I put about 3% of my portfolio in Eurodollar futures calls. This wasn’t a directional bet; I saw it as inexpensive insurance given the cost of these options, the pandemic risk, and the likelihood that rates would drop substantially at even the prospect of recession. This position spiked upward as the COVID crisis hit the markets. I’ve taken the majority of profits off the table, but the position remains 4% of my portfolio. Together these two “cheap insurance” trades contributed about half of my gains.
Third, I made a number of equity purchases in March (especially March 16–20). I exited a few of these at losses, but more than doubled my position in SQ and added several others that are up significantly.
Finally, I had already increased my gold exposure before COVID hit the markets (increasing my gold mining position to 3%, and adding a 4% physical gold position with Precious Yield). I bought more gold stocks between March 16–20 (an additional 10% of my portfolio) because of the long-term appeal of gold in a true crisis or scenario with significant monetary stimulus, and the depressed prices of gold stocks (which briefly seemed more tied to broader equities than to the price of gold). These positions quickly rose as gold recovered and reached new highs, and together these gold positions contributed about 12% to first-half returns.
Several positions got crushed, including my REB allocation given the impact of COVID on emerging markets (I increased this position in late May to return it to 3%). I also allocated more than 4% of my portfolio to puts on a range of stocks and a few other bearish options, beginning Feb 19 and through early April. Though these positions appreciated during market lows in March (cushioning losses from other holdings), most are now down substantially or total losses. These losses do not bother me, as I believed the options had good insurance value that became worthless as markets recovered, and REB’s EM exposure is good diversification; nonetheless they were a moderate drag on performance.
In May, I liquidated my American Funds investments. This was not out of any dissatisfaction with American Funds, but rather the desire to move from a more passive allocation (I’d had the American Funds investment since January 2017, before I launched NF Macro and started actively managing most of my portfolio) to a more enterprise one. These were sold somewhat below their YE 2019 prices and thus also reduced portfolio performance a few percent.
I made one more alternative allocation (~3%) in June, to Rosewood Two, a fund focused on a special opportunity involving Fannie/Freddie. I vetted the thesis and it made sense, but more than anything this was a bet on Rosewood’s founder, Jay Fields, whose philosophy and eye for investment opportunities I respect. (The fund was roughly flat through the end of June, but rose 20% in early July based partly on a favorable Supreme Court ruling.)
I ended June with a much lower cash/bond allocation (18%). I increased my crypto allocation to 4% (still mostly Bitcoin), based on the same themes described above. Gold and gold miners ended at 27% — I have more confidence in gold than in the US dollar as a durable store of value, and believe it also offers a hedge against further economic risks. Direct equities constituted most of the remainder, partially hedged with a variety of mostly-bearish option positions.
In early May I also make a substantial illiquid investment (13% of the value of the Liquid Portfolio) in a controlling interest in a small ammunition manufacturer. This was a unique opportunity to back an operating team I believe in and buy assets at an attractive price (the inventory included in the deal, once finished and sold, should by itself return nearly the purchase price). Beyond this, I believed the firearms industry would be strong for at least a few years given the widespread heightened perception of risk following COVID — a thesis that only grew stronger after the protests of the last few months — and is often an attractive hedge, including against some extreme tail risk scenarios.
We enter the second half of the year facing extraordinary geopolitical, political, and social uncertainty, as well as continued technology-enabled change. Through this, I believe my portfolio is positioned to at least protect much of its value in a wide array of scenarios, and in some positioned to gain significantly.
