February 2018 Commentary

June 2, 2020

Our unconditional duty, and the only one we abide by, is to grow investment capital at an above average rate while avoiding any permanent loss. We measure ourselves against S&P 500, as it represents a wider range of companies including the manufacturing, retail and service sectors companies than Nasdaq index.

We closely follow Warren Buffett and read all the annual letters of Berkshire Hathaway. This partnership structure is similar to the Mr. Buffett’s original partnership that started in 1956 with 7 limited partners, all of whom were close family and friends, began with $105,000 not including a $100 contribution from the managing partner, Warren Buffett. In 2008, Mr. Buffett wanted to prove a point to the investors that an investment in S&P 500 Index fund will outperform 200 hedge fund managers working together and taking a slice of the investment returns. Protégé Partners picked five “fund-of-funds” that it expected to outperform the S&P 500. That was not a small sample. Those five fund-of-funds in turn owned interests in more than 200 hedge funds. Essentially, Protégé, an advisory firm that knew its way around Wall Street, selected five investment experts who, in turn, employed several hundred other investment experts, each managing his or her own hedge fund. This assemblage was an elite crew, loaded with brains, adrenaline and confidence.

The managers of the five funds-of-funds possessed a further advantage: They could – and did – rearrange their portfolios of hedge funds during ten years, investing with new “stars” while exiting their positions in the hedge funds whose managers had lost their touch. All of these managers have huge incentive to outperform the S&P 500.  All these hedge funds were skimming 2.5% of investor’s capital every month, whether they grew the partner’s capital or not.  The results are an eye-opener. These five funds have all underperformed S&P 500 by a huge margin. It speaks volumes as how hard it is for any manager to outperform an index like S&P 500 over 10 years, even though all these 200 managers are relentlessly worked all these 10 years and with the latest AI technologies and Bloomberg terminals.

Here is the summary of their performance after 10 years:

Year Fund-of-funds A Fund-of-funds B Fund-of-funds C Fund-of-funds D Fund-of-funds E S&P Index Fund
Final Gain 21.7% 42.3% 87.7% 2.8% 27.0% 125.8%
Average Annual Gain 2.0% 3.6% 6.5% 0.3% 2.4% 8.5%

This is the exact reason why, Ikkurty Capital is structured with 0% management fees. We make money only when our investors make money. Our fund is structured similar to Warren Buffett’s original partnership that he started in 1956, which did not have any management fee. Lot of hedge funds and mutual funds are structured in a way such that they get a minimum of 2% to a maximum of 6% in management fees. When an investor invests say $100 in a mutual fund which has a management fees of 5%, only $95 of his capital is actually invested in the market. The full amount of his capital ($100) is not compounding but only $95. These fees are not just one-time fees but every year. So, in the second year, assume the fund has no growth, the manager gets another 5% of $95, which is another $4.75. Over the years, this performance degradation caused by the fees reduces the capital available for compounding resulting in huge under performance to an Index fund.

A most popular argument against the purchase of bitcoin is that over the past two years it has produced an enormous rate of return of perhaps a 20+ fold increase in value and there is no fundamental justification for such an increase, because bitcoin has no identifiable financial fundamentals. The problem with this approach of thinking is that people try to compare bitcoin to a typical company like Apple or Google, which has cash flow and financial metrics that can provide an estimate of its intrinsic value.

In reality, bitcoin possesses about the most identifiable and valuable fundamental property of any financial asset, which is a known scarcity value, such that it cannot be diluted or debased. There has never been a form of money with this property that can be employed by the general public. Every known currency in history has ultimately collapsed. There are number of collectible coins that have had known scarcity value, and which have appreciated over time, but they are not mass-market instruments. It is easy to be lost in the complex mathematics of elliptical curves and public key cryptography theorems and SHA-256 hash function of bitcoin, as we dig deeper. However, what brings value is its scarcity which is set to 21 Million coins that are supposed to be produced by year 2140. Bitcoin’s primary enemy is the central banks of the world, which debase our currency. The central banks of both Japan and Australia last year modified their banking regulations to accept bitcoin as a legal means of payment, thereafter removed an excise tax that had been previously imposed on purchases of goods and services made with bitcoin.Bitcoin is slowly proving itself to be great store of value similar to gold. Bitcoin is first global self-sovereign (absent physical violence no one can take it from you), censorship-resistant, scarce, trust-less (requires no third parties) and secure currency the world has ever seen. Some countries are embracing bitcoin, while some are engaged in a battle that they are bound to lose.

Imagine that an objective observer is willing to concede that sudden death of cryptocurrency by regulatory fiat is an extremely difficult undertaking. In that case, the obvious risk is the sudden plunge in value because cryptocurrencies are overvalued.

Bitcoin is one of the cryptocurrencies that some believe have the potential to one day be accepted as a worldwide, non-inflationary currency. The current market capitalization of bitcoin is $152 billion. According to the St. Louis Federal Reserve, the value of the M2 money stock in the United States is $13.455 trillion.

Moreover, this figure is constantly increasing. Last year, the M2 money supply increased by 2.5% greater than GDP. As a measure of loss of purchasing power, 2.5% of $13.85 trillion is $346 billion, which obviously is much greater than the market value of bitcoin.

Over a working lifetime (i.e., over the 50+ years since January 1965), the U.S. monetary base increased 86.3x, or 8.8%/ year.  GDP growth, in constant dollars, was 4.6x, or 2.9% /year. So, $1000 of monetary base became $86,300, while $1000 of economic output became $4600. In that sense, the monetary base was diluted by 95%, roughly 5% per year.  Is something less of a bubble if it loses 95% over an extended period, instead of all at once? The chart below is a picture of the destructive power of a currency being debased, and is the stated policy of the Federal Reserve to inflate the currency at a 2% rate. United States removed the peg to gold in 1971. Notice the expansion of currency increasing in an exponential pace after 1971.

In success mode, a worldwide currency would have a valuation that is at least equivalent to the U.S. M2. Indeed, one could make an argument that it should be worth much more than this figure for several reasons.

  1. A non-inflationary currency is inherently more desirable than an inflationary currency
  2. U.S. M2 is only one part of the much higher worldwide supply of M2
  3. U.S.  M2 is constantly increasing

If bitcoin merely were to attain the current valuation of U.S. M2 and U.S. M2 does not increase, its valuation would expand by 89.7x. If this transformational change were to happen over the course of a decade, it would amount to a 56.95% annualized rate of return.  If it were to happen over the course of five years, it would be a 146.33% annualized rate of return. This reasoning only talks about U.S. M2, while the rest of the world is printing money even faster than United States. People living outside of U.S have experienced enormous inflation, orders of magnitude more than United States. If taken into consideration, should increase the value of bitcoin even more.

In fact, I would go so far to argue that the actual bubble is not in bitcoin but in Fiat currencies around the world. It costs close to nothing to produce large quantities of these paper currencies. However, based on a recent estimate it costs close to $4758 to mint a new bitcoin in United States. This cost to produce a bitcoin can only go up along as the hash rate(currently at 21×1018hashes per second) continues to climb higher.

So, in conclusion, the partners can sleep well at night knowing that their hard-earned money is stored in the best form of currency known to mankind and it is protected by the rigid rules of mathematics.

Managing Partner
Email: sam@ikkurty.capital

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