Paper Portfolio – April 2020 Update

March was a strange month. Saying “the world changed” almost seems like an understatement. Yet, the crazy thing is when Capital Flywheels reviewed the March 2020 Update in preparation for the current update, it’s clear that the world was already changing a month ago in hindsight but Capital Flywheels failed to fully grasp the enormity of the situation.

Despite having awareness of the disruption the coronavirus caused in China as early as mid January, awareness of the potential spread that was underway in the United States (to the point that Capital Flywheels had already been stocking up on essentials since early February and avoided crowded locations), and awareness that experts had limited understanding or tools to counter a pandemic-type scenario, Capital Flywheels still assumed that things would be okay and that stocks were a bargain (while personally building a pandemic bunker)!

As a result, the Paper Portfolio was positioned quite aggressively heading into the fastest and sharpest selloff the United States (and global markets) had seen since the Great Depression. While Capital Flywheels would love to have a do-over for March, it would likely be a mistake to reduce risk now given how much the markets have declined. In fact, many highly attractive businesses are now selling at very attractive valuations. The coronavirus situation will likely still take months to fully work through, but for the long term investor with cash to invest, this is likely a good time to continue to increase ownership in attractive businesses that can take advantage of this crisis to come out better, faster, and stronger. Weak players will die, but the survivors will undoubtedly have a bigger piece of the pie.

March was an extremely challenging month for every asset class, not just equities. Nothing was safe, not even the assets traditionally deemed safe such as gold and treasuries, both of which experienced volatility along with the rest of the market. The elevated volatility across all asset classes likely created a feedback loop that reverberated between asset classes for at least several weeks.

In this environment, our benchmark (S&P500) returned -12.46% for the month (on top of the 8.22% decline in February). While the Paper Portfolio was positioned aggressively entering March, the Paper Portfolio (very fortunately) benefitted from owning the strongest businesses / business models that are likely to not only survive but come out of this stronger. As a result, the Paper Portfolio declined 8.66%, which is 3.8% better than the index. Year-to-date, the Paper Portfolio has returned -6.09%, which is 13.34% better than the index. Since inception, the stock-only portion of the Paper Portfolio (which excludes impact of cash drag in the initial ramp up) has returned 3.7% vs -12.0% for the index.

A number of stocks performed exceptionally poorly. Heading into March, the Paper Portfolio had Square and Uber tied for 2nd largest position with 5.5% weights each. Unfortunately, both of these companies are seeing large impact from coronavirus as restaurants shut down and people stay home. This caused SQ to decline 37%, and Uber to decline 18%. As bad as those declines are, they were, by no means, unique…MELI declined 21%, PINS declined 21%, SBUX declined 16%, and many more.

However, luckily some positions have held up quite well. The Paper Portfolio had just enough working to continue to drive outperformance vs the index. SE, the largest position, only declined 1.66%. Activision actually rose 2.3% since video games are probably in hot demand as people stay home. The biggest winner was Cloudflare (which was also a big winner last month), increasing 10.2%. Since Cloudflare offers cloud/datacenter services, Cloudflare is likely to benefit from the current situation as people work from home and spend most of their days online.

In terms of rebalancing, there are limited major changes. Most weights are being adjusted back to the starting weight or thereabouts to account for the large moves seen in the month.

The only major change is a complete sale of SBUX, which will be replaced by Alteryx (AYX). While Starbucks is an incredible brand, there will be significant near-term impact as people stay home. And the long-term growth profile is only good, not great given the maturity of the story in the US and some developed markets. The current environment allows us to swap into other excellent businesses that are less mature.

Alteryx provides sophisticated, but easy-to-use software that allows companies to prepare and analyze data. Data is becoming incredibly important in every dimension, but not every company can attract (or pay for) high cost data scientists. Alteryx software allows business / corporate analysts that are not trained in data science to prepare and do sophisticated data work. Alteryx effectively helps democratize data analysis and likely has a long growth runway ahead.

Let’s see what April brings.

Disclosures: I own shares in SE, SQ, UBER, SHOP, BABA, MTCH, FB, TEAM, and AYX. I may transact in shares mentioned in the next 48 hours.