POP QUIZ

What percentage of Americans have a passport? (The answer is at the bottom of this newsletter!)

IN THE NEWS

📉 A Wunderkind Hedge Fund’s Big Flop

Benjamin Stein and Zachary Sternberg admired Warren Buffett from an early age, like many young people in finance.

That prompted them to launch a hedge fund, Spruce House Investment Management, in 2006. From the beginning, they found success and managed billions of dollars for clients including MIT, the University of Notre Dame, and wealthy individuals like Barry Sternlicht, a billionaire hotelier.

The Buffett way, sorta: Stein and Sternberg long emulated Buffett’s value investing approach.

• But around 2017, amid a historic bull market and a rise in the popularity of “growth” stocks, they began investing in highflyers. By 2021, they’d grown their assets to $4.7 billion, up from $2.2 billion in 2017.
• Ok, you can probably guess where this story is headed.
• In 2022, the Federal Reserve began hiking interest rates. Tech stocks fell rapidly. Spruce House lost roughly two-thirds of its clients’ money in 2022, well underperforming the Nasdaq’s 33% decline.

Last year was “psychological torture,” they wrote in a letter to investors.

Staying in the hunt: Now, the 38-year-old Penn grads are trying to stay in the game by holding more cash, diversifying their positions, and sticking to their value-investing roots rather than chasing hot tech stocks.

• “It’s important to remember we’re 36, and even though it doesn’t feel this way today, we are just getting started—and this too will be an unfortunate blip on a very long-term chart of our returns,” they wrote to investors amid 2022’s disaster.

This year has been much kinder to Spruce House, which is up about 65%, beating the Nasdaq’s 53% return and the S&P 500 24% gain. But it’s still in the red, reducing how much it makes off its lucrative fees (common for hedge funds).

Why it matters:

The case illustrates a hedge-fund-industry-wide trend of funds dumping money into popular growth stocks during the pandemic. Near-zero interest rates enabled investors to take on more risk, flooding cash into companies that weren’t even close to profitable.

But many hedge funds went under last year, closing their doors. Others recovered this year but are still reeling.

• Stein and Sternberg invested in mostly founder-led firms, using a concentrated, long-only approach.
• By 2021, they’d compounded 20% annually since inception, on par with Buffett (though the Oracle of Omaha has done that since 1965, well before they were born).

For now, the pair view 2022 as a lesson in humility. One of their holdings, Carvana, cratered 98%. As a result, they’re reverting to their original game plan, focusing on consistently profitable companies with little debt — back to basics.

Read more (on stocks that hedge funds and Warren Buffett both seemingly love)

🤔 What to do With Frozen Russian Financial Assets?

The U.S. and Europe are sitting on billions of dollars worth of “frozen” Russian financial assets, seized shortly after Russia invaded Ukraine.

Sweeping sanctions cut off Russian central bank assets from the financial system, and almost two years later, Western governments are considering using Moscow’s money.

While political divides have made it difficult for the U.S. and European Union to approve new aid to Ukraine, the FT reports that “the idea has gained traction in recent weeks” for allocating Russian assets to support Ukraine.

• Around $285 billion of Russian financial assets were seized by G7 countries, with the bulk sitting in Europe, namely in Belgium and, to a lesser extent, France.

Will it happen? The FT states, “Washington hasn’t publicly backed confiscation of the frozen assets, but it has made the case for it privately.”

• The idea is to release funds in waves to Ukraine via the World Bank or the European Bank for Reconstruction and Development, acting as an “advance” payment from Russia as required under international law for its aggression and damages.
• Germany’s Federal Prosecutor is pushing forward with trying to confiscate 720 million euros worth of Russian assets, potentially setting a new precedent for the country, which previously had only frozen the funds.

Why it matters:

The picture for spending Russia’s confiscated sovereign assets is blurry, to say the least, under established international law. Central bank assets have special protections, and violating those protections could carry serious repercussions, undermining faith in the existing global financial system.

• Still, some legal scholars believe the move is justified.

Counterarguments: But trying to seek compensation for violations of international law by reallocating countries’ central bank assets is fraught with implications and may be “unwise,” according to a professor of law at Vanderbilt.

She argues, “Many countries have been damaged by many things that violated international law with no suggestion that we seize foreign currency reserves.”

• Adding, “These are the most sacrosanct kinds of assets in the global financial system.”

Put differently, the concern is how countries worldwide would respond and whether it would discourage them from storing currency reserves in other nations’ banks.

• For countries like China and Saudi Arabia, it might signal that sovereign assets held abroad in U.S. and European banks may not actually be safe.
• Agathe Demarais of Foreign Policy Magazine argues, “Weaponizing Western financial channels like Euroclear (the Belgian financial intermediary company holding much of Russia’s assets) fuels financial fragmentation.”
• She suggests that “If Euroclear were to facilitate the seizure of Russian reserves…Non-Western alternatives to Euroclear, such as China’s Securities Depository and Clearing, could become more appealing for non-G7 economies.”

Read more

🚗 Tesla Wannabes Run Out of Road (and Cash)

Electric vehicle companies are learning that the business is much harder than it looks.

There’s Tesla, then there’s everybody else. The EV makers cruising just a couple of years ago have fallen into serious cash crunches.

• At least 18 EV and battery startups that have gone public could run out of cash next year.
• Companies strapped for cash include Nikola and Fisker, which raised money on the bold ideas of transforming the auto industry and fighting climate change.

Reality sets in: Then came the problems, one after the other, including rising costs, manufacturing and supply chain issues, and competition. It’s an industry with high entry barriers and many moving parts, with little room for error.

• Lordstown Motors, Proterra, and Electric Last Mile Solutions have all filed for bankruptcy.
• The median stock of the companies WSJ analyzed is down over 80% — yes, 80% — from its market debut. The falls are even more pronounced from their peaks, wiping out tens of billions of dollars in market value in just a few years.
• Said one financial analyst: “It was by far the most insane bubble I have ever seen.”

Constant headwinds: That virtually everyone in the industry has struggled except Tesla speaks volumes about how challenging the (EV) auto industry is. It’s a high-volume, low-margin industry, and incumbents dominate market share.

• But EV startups’ struggles also speak volumes about Tesla, which nearly went bankrupt in 2008, almost didn’t meet payroll several times in the early going, and then almost went bankrupt again around 2018, per CEO Elon Musk.
• Today, it’s valued at about $802 billion after its stock price more than doubled this year.
• Many Tesla wannabes went public via SPACs, not IPOs. SPACs enabled them to make unchecked estimates about how quickly they could grow. Virtually all of them have been way off the mark.

Why it matters:

There’s little doubt that the world will continue its transition to EVs, though the precise timetable is uncertain.

• For every Google, thousands of startups failed. The same appears likely for the EV race: For every Tesla, many startups will crash and burn.

Rivian has fared better than most, but it only sells EV pickup trucks that cost about $80,000 — too expensive for the average American.

Other startups went public or raised money in a much different macro environment than the one they’re now in.

• “The (financial) targets were all based on a firm market and full access to unlimited capital,” said one EV CEO.
• As another analyst commented, institutional and retail investors were all “out there looking for the next Tesla.”

Read more

TRIVIA ANSWER

Three decades ago, just 5% of Americans had passports. Today, the number is 48%, with twice as many folks overall carrying passports than in 2007, according to the State Department.