Paper Portfolio – October Update

Over the past month, there has been no shortage of news (or volatility). The paper portfolio performed quite poorly despite having more than half of the portfolio in cash (-3.49% vs +1.87% for S&P500).

September saw significant drawdowns on growth- and momentum-type investments. While the paper portfolio is composed of high quality names, there is currently meaningful correlation between the quality factor and momentum, growth, and low volatility factors.

The current environment remains unpredictable in the near-term, but all of the companies in the paper portfolio continue to benefit from strong structural drivers. These underlying structural drivers are unlikely to be derailed for any extended period of time regardless of where we are in the business cycle, and as a result, these names should remain highly attractive investments over a reasonable investment timeframe.

For October, there are few changes to the paper portfolio. Market weakness is starting to create some attractive opportunities, but having the optionality of cash in the current environment is valuable. I anticipate there may be even better buying opportunities as we head towards the end of the year. Should this assumption not pan out, the current portfolio is compounding underlying business value significantly faster than the S&P500, and hence should perform at least okay in an up-market even with a significant cash drag.

Highlights:

ATVI – Sentiment around Activision visibly improved during September. World of Warcraft brought renewed optimism, and this was further supported by anticipation of a mobile version of Call of Duty in conjunction with Tencent. There’s a lot of optionality in this name, and I can’t wait to see what comes next.

MTCH – Match ended the month down a very significant 15.75%. The stock is likely impacted by IAC’s announced potential spin-out of MTCH shares. Recently, the stock also came under pressure as the FTC sued the company for deceptive marketing practices. The lawsuit certainly casts a negative pall over the stock and governance/management practices at the company, but the assets likely remain sound.

ADYYF – Adyen fell 11.26%, a disappointing outcome for one of the most attractive assets in payments, in my opinion. The stock is likely a victim of its high multiple in a highly volatile market, and management certainly didn’t help by announcing a secondary offering during the month. AQR, a well-known quantitative asset manager, also appears to be short the stock. While there seems to be a number of things pressuring the stock, the underlying business continues to be robust as Adyen appears very well positioned to take share from legacy incumbent merchant acquirers.

SHOP – Shopify fell 19.13%. Shopify is very likely a victim of the current rotation out of growth despite the company taking steps to significantly grow their future relevance and value. Recently, not only did Shopify announce plans to launch their own fulfillment service, the company acquired a robotics maker that should push it closer to the leading edge in terms of warehousing efficiency. It’s a bold plan. But that is exactly what is needed to continue to differentiate and potentially challenge Amazon.

ASML – ASML is a name that few outside of the semiconductor industry have ever heard of, but ASML is likely the most important company in leading edge semiconductor manufacturing. Apple’s A series chips and AMD’s latest 7 nanometer chips are all manufactured on TSMC’s 7 nanometer process. But the machines that make that process possible are only available from ASML. ASML is starting to get the recognition it deserves as TSMC’s 7 nanometer manufacturing ramps up. It has moved from having dominant market share to an absolute monopoly (100% share) in leading-edge semiconductor manufacturing.

SQ – While the stock was roughly flat for September, the journey was anything but. The stock fell significantly as investors digested Square’s sale of Caviar and shifting competitive landscape, but then rebounded towards the end of the month. While I have admired Square for many years, I have always been wary of their dependence on smaller merchants. What makes the company much more interesting now are the recent data points around Cash app, a digital wallet service. Cash fundamentally transforms the business from a differentiated merchant acquirer/software provider to a two-sided network. I like two-sided networks. If Square succeeds in driving growth of the two-sided network, the value would likely be multiples of what they would have likely achieved as a pure merchant acquirer. The set-up looks good. I think it makes sense to raise the weight from 3% to 4%.

MELI – Great business but headquartered in a bad place…MELI is unfortunately an Argentine headquartered company. Argentina is currently in the midst of a crisis and MELI is likely being dragged down with it. While there will likely be some fundamental impact (~20% of revs come from Argentina and approximately similar level of costs), the key drivers for the company are secular growth in e-commerce and payments across all of Latin America and Brazil, in particular, since Brazil makes up about half of the business. Late in the month, MELI was also impacted by the launch of Amazon Prime in Brazil, but Amazon still seems to be dragging their feet there…A 50bps increase in weight makes sense to me.

Disclosures: I own shares in SE, BABA, TCEHY, ATVI, and SQ at time of publication. I have no intention to trade any of the names mentioned in the next 48 hours.