Striving to Consistently Outpace the S&P 500 Index
0% Management Fee, Performance Fee Only
7/1/2020 – 6/30/2021
Annual Letter to Limited Partners
Cavallini Capital LLP.
Greg Cavallini
350 S. Miami Ave. Miami, FL 33130
Results July 1, 2020 to June 30, 2021
Cavallini Capital, including dividends reinvested (herein-after called CC) had an overall gain of 37.91% from 7/1/20 to 6/30/21. The S&P 500 Index including dividends reinvested (hereinafter called the S&P) had an overall gain of 40.81% from 7/1/20 to 6/30/21.
To view track record, please contact Greg Cavallini at greg@cavallinicapital.com.
Cavallini Capital Investor Gains vs. The Competition
Below you will see 5 separate results:
1. An average of all U.S. stock mutual funds. These Funds are actively managed by individual(s) who are the smartest and brightest in selecting stocks.
2. Results from a typical mutual fund that is invested in a similar manner to CC. T. Rowe Price (PRDGX) has Assets Under Management (AUM) of about $14 billion. PRDGX represents a prototypical fund for an ordinary investor seeking to put money in an investment vehicle focused on stocks. Results are represented net of fees.
3. The S&P which is passively managed.
4. Investor gains in CC net of fees.
5. Results of CC.
To view track record, please contact Greg Cavallini at greg@cavallinicapital.com.
Year In Review
The results for fiscal year 2020 were disappointing based on the data illustrated above. The idea is to create separation between CC and the S&P to the upside. Though CC gained 37.91% this year, it did not outpace the S&P. I have mentioned before that I would consider a successful year in which CC returns -10% vs. the S&P returning -20% as opposed to this year’s result in which CC had positive gains. CC will not outperform the S&P every year and in the future there will be more occasions that CC does not beat the S&P.
What is important is that in the long term CC should outpace the S&P (no guarantees, of course). The year to year tally is not of major importance. A 12 month time period is simply not enough time to correctly identify why an investment worked or did not work, but we can try and get some sense of some possibilities. Whenever CC does not outpace the S&P, I like to take a look as to what could have possibly led to this result. Beginning in October of 2020, we started seeing a heavy rotation into two traditional sectors: Traditional Financials (think banks) and Energy. This has continued until at least May of this year. As a reference, there are 11 sectors in the market as per the GICS. Given that CC is a very concentrated portfolio of 6 stocks, it’s only natural that we are not in all the sectors. As a result, CC is currently not in either of the sectors mentioned above. Traditional Financials is a sector I like to stay away from given the murky nature of bank lending practices. However, this seems to be changing as banks change their business model from a lending business to a fee based business. The energy sector is a very tricky sector at the moment with environmental issues as well as large amounts of debt to fund not only ongoing expenses but also exploratory missions. The energy sector is heavy influenced by the violent gyrations of short term oil prices. This is a game I do not know how to play and one which I will not risk my or my investor’s capital. Even though CC runs a very concentrated portfolio, it is actually invested in 5 separate sectors. In other words, you can run a very concentrated portfolio that is also well diversified. However, as seen by this year’s results, from time to time CC will not be in a particular sector(s) that is temporarily outperforming.
Two Changes Coming to Cavallini Capital
1: Calendar Year Basis
Going forward, CC will run on a calendar year basis and not a fiscal year basis. In the future, all results will be shown on a calendar year basis.
2: Lowering Performance Fee
CC will lower the performance fee from 50/50 hurdle rate of the S&P to 35/65 hurdle rate of the S&P. 35% will go to CC and 65% to investor.
Given the two changes mentioned above, please see the results listed below based on the two new changes.
To view track record, please contact Greg Cavallini at greg@cavallinicapital.com.
Inflation
Top of mind to investor at this time is inflation. On the ground level, people are experiencing higher prices in everyday life. Businesses are also reporting higher costs of goods / raw materials, but more importantly wages. Small businesses, which account for the majority of US GDP, are struggling to hire workers back. As a result, they have to create incentives such as paid education and the obvious hourly rate hike. It is only natural that these higher expenses are passed down to the consumer. Cost of transportation has also dramatically increase. This seems to be a combination of the lagging effect of Covid compounded by structural issues. Freight rates from China to US West Coast are up 66% since January and up 400% since the beginning of 2020. Like wise, freight rates from China to Europe are up 92% and 420%. Again, there were warning signs before Covid (lack of quality containers and available space on vessels), but Covid accelerated those issues.
Finally we come to the most telling sign of possible inflation ahead, a rise in the price of commodities. As commodity prices increase, so do the products / services from which they are built. If the price of sugar goes up substantially, naturally the price of products using the ingredient will go up….. think Oreo cookies.
Let’s look at a few key commodities that have increased in the past year.
Lumber: up 275%
Gasoline: up 102%
Copper: up 89%
Soybeans: up 83%
Sugar: up 56%
Wheat: up 37%
The million dollar question becomes, is this increase because of pent up demand and supply chain issues compared to a year ago when the economy shut down or is this increase and possible rise here to stay?
Assuming inflation is here, the question to investors then becomes, how do I protect myself against the ravaging effect of inflation?
Conventional wisdom tells us to invest in such commodities to take advantage of the increase in prices. This can be achieved by buying stocks that have a direct play on commodities or even take the more aggressive approach and wager on commodities future contracts through such markets as the Chicago Mercantile Exchange. Given this line of thinking, let’s look at what the historical numbers tell us.
- Allocating $1 in 1974 equally to a basket of commodities, gold, global value, and Euro equities was worth $38 today. Allocating the same amount at the same time to IG corp. Bonds, Treasuries, US growth stocks, and the S&P 500 was worth $104.
- Historical data shows that a permanent portfolio allocation to inflation assets only hurts returns in the long run.
- Economic experts expect 3.6% average inflation in Q2. Over the past 30 years it has only been higher 5 times (May’01, Sept’05, June’06, and June’11). On average investors who bought inflation assets on those triggers suffered losses over the year: comm. -10%, value vs growth -2% EU vs US equities -3% and cyclical vs defensive -1%. Only TIPS saw a small positive return but 10 year TIPS yield 0.93%.
* data provided by BofA RIC Report
The long term data shown above does not illustrate a rosy picture. However, speculators will contend that commodity fluctuations are not about long term investing, but rather savvy trades. Without doubt there must be speculators out there who did, have, or will take advantage of the situation and come out on the winning side. The question is, can it be done on a consistent basis for many years. A trader might think since commodity prices will go up, the value of future contracts will also go up, thus you simply buy futures contracts. End of story right, Wrong, because for every futures contract out there the trader is hoping will go up in value, large companies are on the other side trying to keep prices down. Such examples are Coca Cola keeping corn syrup price down as much as possible, The Mars company keeping sugar futures down as much as possible, and of course big chemical companies trying to keep oil futures low. As a trader, you are left in the middle of the battle field with enemies on both sides, the people cultivating the commodity and the producers that use those commodities for their products.
The case against current inflation can also be made. As people cite inflation data today on a year over year bases, it can look like a large increase. However, the base rate is not giving investors an accurate picture. The base rate in this case is early 2020 when the economy collapsed along with prices. Suppose you had $10 in a bank account before the pandemic, then during the pandemic the dollar amount went down to $6. Now that $6 has jumped to $8. The year over year change is 33%, but you are still down 20% from the pre-pandemic level.
Same can be said for current inflation data. The consumer price index in May was up 5.4% year over year. If we take the perspective of looking at the data from 2 years ago, the scenario changes. On average, the consumer price index has risen 3.5% every two years during the last decade before Covid-19. In May this year, the index was up 2.5% from two years ago, which tells us that inflation is ticking higher but not exceptionally higher than usual, and in line with what the Fed has been signaling for some time.
In conclusion, inflation can go up or it can go down or remain the same. This is a fact that is out of our control. Our focus is to keep an eye on the businesses CC owns. Many of the businesses will benefit from inflation because after all, stocks are a good hedge against inflation. Understandably, as inflation rises so do bond yields. This creates a higher bar for the risk premium of stocks, thus having an impact on the valuation of all stocks.
Cavallini Capital is accepting investor capital at this moment. If you are interested, please contact Greg at greg@cavallinicapital.com.
Note:
Ana and I have the majority of our investable wealth in CC and so long as CC is in operation, this will always be the case.
I can’t promise results, but I can guarantee that our wealth will be in lockstep with yours.
Sincerely Yours,
Greg Cavallini
Notes:
The record above displays Cavallini Capital’s track record since inception on July 1, 2017.
Disclaimer: Greg Cavallini, as General Partner of Cavallini Capital, LLP, makes no representations or warranties to investors regarding the probable success or profitability of Cavallini Capital, LLP, and the Track Record, Results and Comparisons set forth herein shall not be used as an expectation on benchmark for any new investments or ventures.