Leaven Partners Q3 2024 Letter To Partners

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Pricey Companions,

Within the third quarter of 2024, complete fund property declined by -1.4%. For the three-year interval, the fund is up 15.3% ¹ in comparison with the S&P 500 (SP500, SPX) return of 38.5%.

On the heels of disappointing efficiency within the earlier quarter, we skilled lackluster leads to the third quarter. Strong efficiency within the first quarter has saved us in optimistic territory for the 12 months. Our core holdings appreciated barely within the quarter, contributing 1.5% to complete gross returns, however woefully underperformed the benchmark fairness indices.

Beneath the floor, our core holdings skilled a risky journey within the quarter. On August 5 th, the Nikkei (NKY:IND) dropped 12% in sooner or later! This was one of many steepest declines previously 40 years. Over three days, Japanese equities have been down roughly 20%. It’s unimaginable to know for sure the reason for the sudden drop; essentially the most accepted narrative is the unwinding of the yen carry commerce that I referenced in my earlier letter. The Financial institution of Japan hiked rates of interest for the primary time in 17 years, coupled with a weak U.S. July Jobs report, are the most probably catalysts for the surge within the Japanese yen. Certain, the Financial institution of Japan was dissatisfied with the elevated instability within the public markets and responded by explicitly stating they might not increase charges additional till stability returned. It seems their soothing language had a chilled impact on the markets as issues started to stabilize. Our Japanese holdings weren’t proof against the sudden downdraft. It was a fast journey down! In about 2 days, we noticed most of our positive aspects on the 12 months evaporate. We spent the remaining quarter slowly clawing our method again into optimistic territory.

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Associated to the surging yen, our overseas foreign money technique made a detrimental contribution of -0.6% within the quarter, giving up a few of the positive aspects earned within the earlier two quarters. We began the quarter brief the yen, with the yen at round ¥161 to the greenback. The yen started its appreciation versus the greenback in July, accelerating in early August. We have been pushed out of our brief place on the yen at ¥155 close to the tip of July, because it hit our cease loss. The yen completed the quarter at round ¥143. Though we skilled a optimistic impact from being lengthy the yen because it continued to understand within the quarter, it’s not mirrored within the efficiency of the FX Technique-as it solely calculates a efficiency return once we are brief the yen. General, the technique has been useful to the fund-not solely in smoothing out returns from 12 months to 12 months but additionally in offering a little bit of added profitability. I plan to proceed to implement the technique going ahead. Though we have been lengthy the yen for the rest of the quarter, we lately went brief the yen because it devalued by means of a channel breakout and established a weakening development.

On a extra sobering observe, the hedge technique continued to have a detrimental affect on returns. This quarter, the frustration was notably acute as a result of sharp pullback in August, (inflicting volatility to spike to its highest ranges since early COVID), and speedy bounce again to new highs. The hedging technique is designed to offer safety throughout sustained market strikes to the draw back. It isn’t, nevertheless, designed to do nicely in uneven waters: huge strikes down with fast reversals to the upside. As luck would have it, we skilled extraordinarily uneven waters within the quarter. Our hedge positions have been triggered on because the market started to fall precipitously, solely to quickly be whipsawed again off as markets rapidly reversed course. We lined our brief positions at a loss. We had one lone brief place, Invesco DB Oil Fund ETF (DBO), that we lined on a realized acquire, that mildly offset our different realized losses. However the two workhorses of the technique, the S&P 500 and the Nasdaq 100, each had materials losses. We’re at the moment not in any brief positions underneath the hedging technique.

By design, the hedge technique isn’t structured to earn cash usually. The truth is, over longer intervals it’s almost assured to lose cash. By implementing a trend-following strategy, the hedging technique is designed to have optimistic returns throughout sustained and extended market downturns. With out sustained and extended market downturns, the technique is destined to lose cash. As I’ve talked about in prior letters, I don’t intend to implement a hedge technique, or tail-risk technique, within the fund at all times. The truth is, I assume that in most intervals throughout the lifetime of the fund, I cannot use a hedging technique.

It’s completely believable then to debate the efficacy of a technique that’s designed to lose cash over time-particularly in mild of the truth that now we have misplaced cash persistently on our hedging methods since I applied them in 2021.

It’s well-known that valuation alone can’t be used as a timing software available in the market within the brief run. Though valuation has some predictive capabilities over longer intervals, say 8 to 10 years, it doesn’t maintain up nicely underneath shorter intervals. Nonetheless, I do consider that valuation ought to at all times be used to assist one in offering cheap future expectations-and, in uncommon instances, ought to sober one into taking pause.

In its easiest expression, valuations at present are two normal deviations above their historic development. Though a easy price-to-sales ratio (proven under) can not predict near-term market actions, at two normal deviations above the norm, it ought to, as a minimum, urge us to pause.

The pause is warranted, for my part, as a result of the final time ² we have been at 2 normal deviations above development, the S&P 500 went down almost 50% and the Nasdaq 100 went down almost 80%, giving up all of its positive aspects throughout the bubble.

I proceed to consider that decreasing volatility within the fund is an goal worthy of consideration. Gunning for the best returns sounds nice, however to be able to end first, first you could end. Though it looks like driving with the brakes on, our hedging technique is designed to assist defend us from a few of these catastrophic losses-that will not be solely emotionally painful however can take years to make up for the losses.

Chances are you’ll surprise why I’m involved when most of our cash is abroad. First, (which is a bit anecdotal), our fund noticed vital losses within the fourth quarter of 2018 throughout the fast market correction within the US resulting in the “Fed pivot”-when it’s fairly logical to argue that the occasion ought to have had little to do with our holdings. And second, which is extra necessary, as the worldwide financial system turns into extra linked, it has been proven that the correlation of returns between markets has gone up over the latest a long time. What was as soon as a greater supply of diversification throughout instances of idiosyncratic stress, is much less so now. In different phrases, when the you-know-what hits the fan, fairness markets world wide have a tendency in direction of a correlation of 1 these days.

With the vast majority of my web value within the fund, coupled together with your hard-earned financial savings, I goal to steer by means of these precarious instances as fastidiously as potential.

In Closing

I’m grateful to your participation in Leaven Companions, and that you’ve entrusted me with managing your property. I sit up for reporting to you at our subsequent quarter-end.

Within the meantime, if there’s something I can do for you, please don’t hesitate to contact me.

Sincerely,

Brent Jackson, CFA

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