Vailshire Partners Hedge Fund Client Memo — 1Q 2022

To clients and friends of Vailshire Partners LP hedge fund:

  • The fourth quarter of 2021 started with a bang before ending with a whimper
  • The Federal Reserve just made a critical policy error, bringing back unpleasant memories of 4Q 2018
  • Unfavorable economic indicators mean a material shift in investment strategy for Vailshire Partners LP throughout 2022

Performance Review

From Bullish to Bearish in the 4th Quarter of 2021

Vailshire Partners LP hedge fund spent the majority of 2021 on an uncharacteristically uncomfortable rollercoaster ride. This continued into the fourth quarter as well, with a huge October gain being followed by losses in both November and December.

In October, our fund increased an impressive +36.18%. However, November returns were -2.79% and December returns declined a material -23.36%. This combination resulted in a 4Q 2021 total (unaudited) performance of +1.46%.

In early November, bitcoin (an increasingly leading economic indicator) began to “sniff out” decelerating economic growth and inflation in 1Q 2022. While our fund remained positioned for a year-end surge in bitcoin and related assets, the price action simply turned bearish, and this has continued on into the new year.

As the table (below) shows, Vailshire Partners LP investors gained +8.14% overall in 2021. While this performance is adequate, I consider closing any year lower than the S&P 500 total return to be suboptimal. Our annualized returns over the past three- and five-years–measuring +41.59% and +24.76%, respectively–continue to outperform the S&P 500 by a wide margin.

As the 4th quarter of 2021 revealed, the market does not always conform to our data-driven, full-cycle investment strategies in the short-term, but the odds remain heavily on our side for significant outperformance over the long-run.

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Current Market Conditions

While I was admittedly hoping for a longer runway for volatile risk-on assets into the beginning of 1Q 2022, the market has spoken otherwise. And when the facts change, so also do my strategies for investment.

A few important metrics have changed since my last quarterly update, which have turned my outlook from cautiously bullish to decidedly bearish and defensive.

First, my research indicates that both inflation and US economic growth have likely peaked in 4Q 2021. This means that GDP and inflation will likely decelerate over the next couple of quarters. Under such conditions, certain risk-off assets tend to be favored, including the US dollar, US treasuries, gold, housing stocks, healthcare, and other “safe havens.”

Second, I believe that the Federal Reserve just made a material policy error. Up until the end of 2021, the Fed has been excessively accommodative in their stance towards the economy and markets, with ongoing large purchases of US treasuries and mortgage-backed securities (MBS), drastically increasing the money supply, and maintaining short-term interest rates near 0%.

I believe that they should have used the strong underlying economic indicators and market fundaments throughout 2021 to drastically reduce their dovish policies. Instead, now that we have entered 2022 and the economic cycle has peaked, the Fed recently decided to taper their treasury and MBS purchases with aggressive rapidity, then quickly raise short-term interest rates.

Why do I consider this to be a material policy blunder on their part?

Ironically, this is quite similar to the overly hawkish “autopilot” policy stance the Fed took in late September 2018, which led to a dramatic market downturn in 4Q 2018. You may remember that Fed chair Jerome Powell subsequently made a dramatic and very public policy decision reversal — a dovish pivot –around Christmas of 2018, which led to an instant and lasting move higher in the equity markets.

Since the cycle has turned and the Fed’s actions have become (I believe) too hawkish, it is clearly the time to be more cautious in our investment strategies. Based on the cyclical nature of business cycles and inflation, I suspect better days for risk-on assets will reappear in the second half of 2022. But, until then, it is wise to take a cautious and measured approach.

As you know, Vailshire has a dual mandate of growing and protecting the assets of its clients. It is clear to me that we are officially entering into a period of “protection.”

1Q 2022 Investment Strategy

From Growth to Protection Mindset

Given the above-mentioned prospects and outlook, our fund (and other separately managed accounts) has undergone a material change in its composition for the coming quarters.

First, our high growth stocks, composed primarily of our FILMS (Founder-led, Innovative, Long-term value creator, Master capital allocator, Stakeholder-friendly) businesses have been sold. These stocks performed well over the past few “risk-on” years, but tend to get hit hardest when the stock market crashes.

In their place, we have added ten of the most capital-efficient companies in existence. These companies know how to generate profits and reward their shareholders in almost any economic condition. If the United States heads into another recession and/or the stock market collapses, these equities tend to experience less volatility and rebound quickly. For this group of resilient equities, I am targeting a compound annual growth rate (CAGR) of 20-30% over the next several years.

Second, I have reduced our exposure to bitcoin and related assets for the time-being. While we still hold a core allocation of bitcoin, we are also increasingly hedged against further downside via various methods, including active shorting of bitcoin miners and crypto exchanges.

Going forward, our approach to buying and selling bitcoin will be entirely quantitative. That is, more bitcoin will not be added to our portfolio unless certain price action criteria have been met. Similar rules will be used to determine the most advantageous time to sell as well. In short, these metrics and rules will allow us to maximize future bitcoin gains while minimizing losses. I believe this will have a dramatic effect on our fund performance throughout the 2020s.

Finally, we will continue to use a sizable portion of the fund’s proceeds to follow our innovative full-cycle, systematic investment approach. For example, when underlying metrics signal a cautious approach (as they currently do), we will increase our hedges and safe haven assets within the fund. This should serve to minimize losses and even profit during market downturns.

Another year has passed and the Vailshire family is growing faster than ever! Thank you for your continued trust in Vailshire’s systematic and innovative approach to investing. Our current defensive strategies should serve us quite well for the coming quarters. And, following this period of defensiveness, I am hopeful for a robust performance in the latter half of 2022.

For current non-clients: If you would like to discuss what Vailshire’s innovative investment strategies can do for you and your family, please do not hesitate to reach out to me personally via email (jeff@vailshire.com). This is not a solicitation to invest but, rather, an invitation to inquire more.

Living well and investing wisely with you,

Jeff Ross

P.S. I was recently honored to receive an invitation to speak at the upcoming Bitcoin Conference from April 6-9 in Miami, FL! This is the world’s largest Bitcoin conference… with over 35,000 expected to attend. If you would like to learn more about this exciting conference, feel free to follow this link. Maybe I will see some of you there!