John Burbank Shuts Flagship Hedge Fund, Plans Launch Of Cryptocurrency Unit

The writing for John Burbank"s Passport Capital was on the wall back in August, when as we reported, in his latest letter to investors Burbank reported that at what was once a multi-billion fund, total firm assets at Passport had shrunk to just $900 million as of June 30 as a result of net outflows totaling a whopping $565 million, or a nearly 40% loss of AUM due to redemptions. The collapse in assets took place just a few months after Passport announced it was liquidating its long/short strategy in April.

And unfortunately for Burbank, just four month later, a chapter of Passport Capital"s history comes to a close, because as Bloomberg reported, the fund would shutter its flagship hedge fund after returns slumped and following unprecedented redemptions. Passport - which shot to fame for its lucrative bet against subprime housing ahead of the global financial crisis - peaked at around $5 billion but lately managed a fraction of that after a double digit loss last year and further losses in 2017.

The fund’s "returns over the past two years are unacceptable and cause me to rethink how to manage money in this environment," Burbank wrote in a Dec. 11 letter to investors, the Wall Street Journal first reported overnight. Passport will continue to operate its roughly $300 million special opportunities fund, which holds some of the firm’s more successful bets on companies such as Alibaba Group Holding Ltd.

As Bloomberg reminds us, Burbank founded Passport in 2000 which was best known for its big bet on a tumble in subprime mortgages in 2006. His fund made 220% the following year, ushering in the good times - if only briefly - with Passport AUM briefly hitting a peak of $5 billion before a double-digit loss last year and more losses in 2017, as we reported previously. Total assets declined to $2.4 billion in April, then plummeted further to $900 million amid client withdrawals and after it wound down its Long-Short Strategy fund after an "incredibly disappointing 2016," Bloomberg reported earlier this year.

“You will not hear about Passport shutting down -- there is too much opportunity available to do that,” Burbank wrote, adding that the firm may announce a new area of investment in the near future.

Well, yes, hedge funds rarely want to publicize that they are closing. And yes, even as Passport the hedge fund as we know it no longer exists, the company has decided to pivot into Mike Novogratz" sandbox, and as the WSJ reports this morning, even as Burbank"s hedge fund is pulling back from traditional investing and trading, it is launching a new arm that focuses only on cryptocurrencies such as bitcoin. More from the WSJ:

Despite his recent performance, Mr. Burbank’s pronouncements remain closely followed by his peers. He would become one of the more prominent major investors to go big on bitcoin and the like, along with the former Fortress Investment Group hedge-fund manager Michael Novogratz and Horizon Kinetics Chief Investment Officer Murray Stahl.

To be sure, the burly John Burbank - a Duke University graduate - is in some ways an unlikely evangelist for digital currency. As the WSJ describes him, "he made his name buying up credit default swaps ahead of the financial crisis, resulting in a more-than 200% gain for his main fund in 2007. That year, he made $370 million personally, Forbes estimated."

His predictions have mostly failed to pan out since. Passport bet big on gold mining companies in 2014, but prices dropped thereafter, and slashed its overall exposure to rising stocks in early 2015, missing out on some of the subsequent rally.

Burbank"s interest in bitcoin and cryptos is hardly new, however, and was reinforced in his last investor letter in which he shared the following perspective:

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.

Burbank continued in Monday"s letter:

“Technological progress and its non-linear enhancement or deflation of the biggest industries and markets in the world is my choice for what will have mattered most five years from now. I want to capture these extraordinary outcomes in new ways appropriate to the current era.”

The new cryptocurrency-focused fund’s leadership will include longtime Passport executive Seth Spalding, the WSJ said. While Passport hasn’t told prospective investors much about its strategy, but has scheduled a call for later this week to lay out more.

It is unclear if bitcoin - in addition to everything else - will also emerge as a "hail mary" pass for fading hedge fund managers desperate to attract just enough capital - through the use of buzzwords or otherwise - to stay in business for just one more lap. If Burbank is successful, watch as every other hedge fund and family office promptly launches their own [Insert Name Here] Crypto Asset Special Situations LLC.

"Game Changer"

Authored by Paul Brodsky via Macro-Allocation.com,

Investors understand that asset markets are experiencing dynamic change (think ETFs), but have not yet broadly recognized that the fundamental nature of wealth itself is changing too. Before the decline of active asset management runs its course there will be an imperative to focus on active currency management. Wealth maintenance and creation demands a clear understanding of this transformation. 

Debt Tokens 

The majority of us are not as rich as we think. Our wealth is held in debt tokens or assets denominated in them with increasingly dubious prospects. Some accounting identities are in order.

Classically, an asset is something with intrinsic value that transcends time and money. It has some value no matter how or when one measures it. Only two people – a potential buyer and seller – need to value something for it to be an asset.

A currency, meanwhile, is a unit of account that provides users with a means of measuring and exchanging value. In a hypothetical barter economy, production itself is would be currency. Currencies representing saved wealth are necessary because we need to value goods, services and assets relative to each other.

Modern currencies are widely misunderstood. They are actually the product of bank system double-entry accounting – ultimately un-reserved, 100 percent faith-based obligations of centralized entities (governments, central banks or currency boards) to manufacture enough actual base money in the future (i.e., inflate) to settle all claims for money that was already created by private banks through the lending process. It is important to note that credit and credit-currencies are claims on money, not claims on assets. Depending upon how one counts, there is either 3 times (M2), 5 times (bank assets), 12 times (total credit market debt), or 25 times (total unfunded liabilities) the amount of claims on US dollars than the amount of actual US dollars in existence (base money). There are no plans to remedy this overwhelming leverage. In fact, this month the Fed is beginning to increase currency leverage again by reducing the size of its own balance sheet, which will effectively re-leverage banks by reducing bank reserves.

This state of monetary affairs is a big deal for financial asset investors. As it stands today, investors could not hypothetically exchange all assets (or liabilities) for base money, or even for credit currencies (M2), at or near current prices. To do so, banking systems would have to first create new liabilities, which in turn would dilute and diminish the purchasing power value of currencies in which assets are denominated.

To be good money, a currency must also be a store of value, meaning it also has to be an asset or be backed by an asset. In the current regime, there are no assets with quantifiable value directly associated with fiat currencies…other than the ability to tax.

The ability to tax is indeed an asset of governments, but one with greatly diminished value. In the US, fiscal year 2016 tax revenues were $3.3 trillion.1 Meanwhile, baseline government spending was about $3.4 trillion, including $1.06 trillion for Medicare and Medicaid; $910 billion for Social Security; $600 billion for non-defense discretionary spending to fund federal departments and agencies; $585 billion for the Defense Department; and $240 billion for interest on federal debt.2 These expenditures are rising faster than tax revenues and do not include truly discretionary government spending. (It seems legislators only have true discretion over how they deficit-spend.) 

While the incalculable value of assets of the United States government (including its strong military and hegemonic control over shipping lanes and bilateral trade) may exceed its currency obligations, such assets cannot be transferred to creditors (i.e., dollar holders) to satisfy obligations. Thus, from both stock (leverage) and flow (budget deficit) perspectives, the US dollar is a very poor credit in real terms. Indeed, other fiat currencies may be worse and all of them are effectively unreserved debt tokens.

The quantity of systemic liabilities – including debt-based credit and credit-currencies – has come to vastly exceed the forward real value of unencumbered assets (adjusted for necessary currency devaluation). It is not possible to net all assets against all liabilities without dramatically reducing the real purchasing power value (PPV) of assets. What does this imply for assets denominated in credit-currencies? Today’s wealth has been borrowed to such an extent that it cannot be broadly recognized in the currencies in which assets are currently denominated. Looking forward, we think the most influential input into wealth creation will be getting the underlying currency right.

If today’s currencies are, in realty, unreserved debt tokens, and assets are denominated and measured in them, then how does one value assets in real terms? Here’s three-step logic we think makes sense:

1. Take the nominal value of an asset priced in a certain currency

2. Adjust the nominal value by the implicit leverage embedded in that currency

3. Present Value the future nominal cash flows of the asset against future currency dilution

Applying this metric makes clear that assets – equity, debt, plant, equipment, labor, goodwill, whatever – priced in certain currencies may hold significantly more or less value today than similar assets priced in other currencies with similar nominal asset valuation metrics (i.e., P/Es, Price to Book, Cap Rates, etc.).

Not surprisingly, assets have taken on many of the qualities of currencies, which makes sense given that both are effectively unfunded obligations. Neither assets nor currencies can have intrinsic value. Currencies may only be valued against other currencies and assets may only be valued against other assets. Is it any wonder that financial asset markets have become places to “save” and that low-cost passive investment vehicles like ETFs are becoming the vehicles of choice? It was inevitable that today’s government-sponsored, bank-executed monetary system would eventually be disintermediated, and the shift to “saving” through passive investing in asset markets is a step in that process.

Value Exchange

What happens when value begins to be exchanged directly on the internet itself, rather than through centralized portals that sit atop it like toll booths? Block chain technology is effectively an open source triple-entry accounting system that includes all participants in the value transfer process. The combination of the technology, its applications, and its accessibility are genuinely transformative.

What will happen to the value of highly-leveraged credit-currencies relative to less leveraged or zero leveraged stores of value that arise from this transformation? What will happen to Foreign Exchange (FX) cross rates in a peer-to-peer world where nothing is foreign? What about the real value of assets?

Looking forward, a growing portion of value, regardless of what form it takes, will be exchanged peer-to-peer, and any value leftover will be stored in whichever form counterparties agree – fiat currencies, cryptocurrencies, commodity-backed currencies, maybe even direct claims for commodities, goods, services or equity.

Value Exchange (VX) rates could look something like the hypothetical table below:

Table 1: Hypothetical Value Exchange Rate (VX) Table - 2027

We should expect value to flow directly between producers and consumers of that production, rather than through public and private sector intermediaries charging them rent. Rentiers and sovereign authorities will formally embrace this brave new world – not out of a sense of altruism, but because the technology is already here and human incentives cannot be denied.
 

Passport Global Slammed With Over 60% In Redemptions In Q2

Back in April, we reported that the Long-Short Strategy Fund of John Burbank, one of the handful of investors who made a killing from shorting subprime, and head of what was at the time the $2.4 billion Passport Capital, was shutting down after a series of negative returns: according to HSBC, the fund - which had an AUM of $636 million as of March - had lost 2.1% in the first two months of this year and was down 11.8% in 2016. As we further reported, a catalyst for the closure appears to have been the January 2017 decision by the San Bernardino employees fund to pull its funds from Passport.

Fast forward to today, when in his latest letter to investors, Burbank reports that at what was once a multi-billion fund, total firm assets at Passport Capital have as of June 30 shrunk to just $900 million as a result of net outflows (not including the Long Short hedge fund strategy liquidation, effective 4/30/2017) which totaled a whopping $565 million, or a nearly 40% loss of AUM due to redemptions.

Worse, Burbank also reports that his flagship Passport Global fund has been virtually wiped out, and following $480 million of outflows, or a stunning 63% in assets under management, net of redemptions Fund assets as of June 30 stood at only $275 million, to wit:

Capital Flows: For the second quarter, the Fund had net outflows of $480 million. Firm-wide, net outflows (not including the Long Short hedge fund strategy liquidation, effective 4/30/2017) totaled approximately $565 million. At quarter-end, net of June 30th redemptions, Fund assets stood at $275 million and Firm assets totaled approximately $900 million. 

That said, aside from these devastating capital outflows, Burbank marches on, and reports that the funds was up 1.6% in Q2 net of fees. Additionally, following the shuttering of the Long/Short fund, Burbank says that the firm"s new focus will be as follows: "Lower gross exposure: ranging between 160% and 170% for most of the quarter; Lower turnover; Lower number of holdings (halved since the first quarter, from 150 names to 70). Despite higher concentration, with risk diversification of the long book, lower gross exposure and maintenance of risk limits, we have maintained realized volatility at the low end of recent historic averages at approximately 11%, as well as low realized correlation with the broader equity market."

Finally, here are some additional observations from Burbank in his latest letter. First, on Macro:

As mentioned, we intentionally reduced our directional macro bets and U.S. policy-dependent exposure which appears to be the right positioning, as this year has provided some surprises, most notably with regard to the USD, as well as its typical relationship with gold and oil. Contrary to expectations, the trade-weighted dollar index peaked on January 3rd and is now below its level immediately prior to the presidential election in November 2016. It is clear there has been very limited follow-through on pro-growth policies promised by the current administration, and as a consequence broad expectations, as measured by the Citi Economic Surprise Index, peaked in mid-March and have dropped precipitously since then; it is now at a five-year low. The University of Michigan Consumer Confidence is also at its lowest levels since November 2016 (election month) and is in a downward trend. The bond market is reinforcing this view (yields lower/curve flatter). Even after the recent bounce following discussion of rate normalization, the 2/10yr remains at pre-election levels after almost reaching the post-crises lows set in August 2016.

Dollar weakness could easily persist; 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.

We believe a weak-dollar environment could be good for commodities, but surprisingly the fundamentals of oil, in particular, have overwhelmed the weak dollar (this is consistent with our view on oil and represented in our neutral oil construct).

Further, core CPI inflation remains weak, and we believe the bond market is not yet convinced that the U.S. will sustain sufficient nominal demand growth momentum to push inflation sustainably back to the Fed’s  2% target. We are carefully monitoring discussions regarding the debt ceiling, given the Trump administration’s push for a debt limit increase before the August recess. In our opinion, if an agreement is not reached, the Treasury may use interest receipts held at the Fed (approximately $150 billion) to pay bills. Perversely, this could act as incremental fiscal stimulus—as it represents an injection of more cash into the market.

The potential consequences of Fed balance sheet normalization are also important. We understand the Fed intends to gradually reduce securities holdings by decreasing its reinvestment of the principal payments it receives, which would potentially reduce principal reinvestment by an aggregate of $10 billion per month (Treasuries & MBS) and would increase in steps of $10 billion at three-month intervals over 12 months until it reaches $50 billion per month.

Some estimates suggest that global quantitative easing (“QE”) will turn negative in 2019 after being consistently positive by about 2% of Global GDP in every year since 2011 (e.g., since 2007, the Fed’s balance sheet has increased by approximately $3.5 trillion). While it is believed this could result in a much steeper yield curve and tighter financial conditions, the Fed continues to give itself substantial policy leeway.

However, the consequences of 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). Balance sheet normalization could be offset by the Fed adopting an easier path for short-term interest rates than it otherwise would have chosen, and the Fed is going to be cautious out of concern that any decision to shrink the balance sheet might be seen as tightening monetary policy. Ironically, reducing the balance sheet could have a stimulating effect, by reducing excess reserves on deposit (which sit idle) and freeing up Treasuries which provide liquidity to the market. It will also potentially allow the collateral reuse rate to increase as balance sheet space on banks becomes more available. Although the Dodd-Frank Act and Basel accords make it more expensive for collateral to be reused, the increase in balance sheet space of the banking system may outweigh the regulatory cost.

Finally, 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.

... on Energy:

We remain bearish on oil. Currently the market is slightly undersupplied, with inventories peaking now but likely to decline sharply in Q4 and then flip into an oversupply during the first half of 2018.

OPEC, and its attempts to manage price higher, is frustrated by U.S. shale oil producers’ indifference to OPEC’s desire, and seems eager to hedge production in the high-$40s to lock in positive rates of return and mobilize rigs. We believe this dysfunctional dynamic is now appreciated by OPEC, putting future compliance at risk. The downside risk to price is a consequence of 1) robust U.S. production that we expect will inflect higher during the second half of this year, 2) sustained gains in Libyan and Nigerian production (not subject to OPEC compliance), and 3) increasingly poor compliance by OPEC members. The potential upside risk to prices stems from stronger than expected demand, disruption in supply (Venezuelan production, for instance, continues to drop), and U.S. underwhelming on production increase.

... and on AMD and Cryptos:

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 (over 5% in one quarter), and we expect those trends to continue, possibly even accelerate, in the server market. Based on these trends, our expectation is for AMD to generate earnings significantly ahead of sell-side estimates for 2018 and 2019.

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.