Flax Pond Capital – 2024 Year End
Flax Pond Capital – 2024 Year End Summary
As we enter 2025, our investment outlook centers around five primary concerns: an expensive US stock market (US Mega Cap stocks are very expensive), inflation risks exacerbated by tariffs, recession risk, the growing U.S. budget deficit, and dysfunctional US and global politics.
To navigate this environment, we have positioned our portfolio across eight investment themes: short duration US govt. bonds, international stocks, baby bonds, biotech, energy, US small cap value stocks with specific catalysts, value orientated yield plays
Key Concerns:
Low Equity Risk Premium/High Valuations: The equity risk premium has diminished over the past few years resulting in elevated valuations and a lower expected return on equities relative to bonds. This dynamic poses a challenge for investors seeking adequate compensation for owning stock. Our response involves prioritizing investments in sectors and geographies where valuations remain attractive or asymmetric as well as owning short duration high quality bonds yielding (4%-5%).
Inflation Risk and Tariffs: Inflation remains a persistent risk. This environment necessitates a focus on sectors that can act as inflation hedges or have pricing power. Gold & gold equities, a traditional inflation hedge, is a core portfolio component of ours. Additionally, our energy investments traditionally act as inflation hedges.
Recession Risk: Recessionary pressures, influenced by monetary policies and slowing global growth, call for a balanced portfolio that includes defensive and growth-oriented assets. Baby bonds, with strong structural protections, offer steady income (7%-8%). Biotech, on the other hand, provides high growth potential, particularly as innovation & clinical breakthroughs continue even in economic downturns.
U.S. Budget Deficit: The expanding U.S. budget deficit raises concerns about fiscal sustainability and potential crowding-out effects on private investment. This dynamic reinforces the need for diversification outside of U.S. assets and makes us wary of owning long duration US govt. bonds. Roughly speaking, 40% of the companies we own operate or are domiciled outside the US and all our bond holdings mature within the next 5 years and most within the next 18 months.
Dysfunctional Politics Political gridlock and partisanship in major economies, including the U.S., create policy uncertainty that can deter investment and exacerbate market volatility. Our focus on value stocks/biotech with specific catalysts emphasizes investments in companies with clear drivers and less reliance on macroeconomic or political conditions. Moreover, our yield-oriented stocks provide stability and consistent returns amidst uncertainty. Our gold holdings should/may act as an insurance policy providing protection against bad policy outcomes.
Portfolio Themes / Select Companies / Median Theme Allocation
Short-Term Govt Bonds: Paying 4%-5% they offer safety, yield and flexibility (40-45% median allocation)
International (Brazil/China): Both countries are cheap according to historical measures and we can own some of the best companies located there at very reasonable prices. Brazil is currently sporting a dividend yield of above 8%. EWZ – the Brazilian market ETF Alibaba, JD.com, PDD Holdings, 6% median allocation
Baby Bonds: Baby Bonds provide a unique combination of income and capital preservation. These instruments help mitigate downside risks while offering attractive yields (7%-8%) with very low credit risk. (Misc. names maturing in 2028-2030 timeframe - 15% median allocation)
Biotech: Biotech remains a high reward sector driven by innovation, demographic trends, and increased healthcare spending. Our investments focus on companies with strong intellectual property, knowledgeable investors syndicates, and the potential for breakthrough therapies, offering us asymmetric return opportunities. (i.e. Structure Therapeutics, Revolution Medicines, Ideaya Biosciences, Bicycle Therapeutics - 6% median allocation)
Energy: The energy sector benefits from a valuation dislocation driven by the global energy transition and prior poor capital allocation mistakes. Our focus includes companies with strong free cash flow being returned to stockholders, disciplined capital allocation, and exposure to excellent geology & as well as sound environmental stewardship. Energy also acts as an inflation hedge. Veren, Geopark, Murphy Oil, Canadian Natural, Talos Energy, Valaris – 9% median allocation)
Value with Catalysts: Undervalued companies with clear catalysts Limoneira, James River, Mativ, IAC, Driven Brands, Couchbase – 17% median allocation.
Value Yield Plays: Investments in mispriced dividend-paying stocks and income-generating assets offer stability and consistent returns with revaluation upside. These plays are particularly valuable in a volatile environment, providing steady cash flows to counterbalance potential market drawdowns. UGI – regulated gas utility, Bell Canada – phone/internet/fiber, Pfizer – big pharma – 4-5% median allocation
Gold: Gold’s role as a safe-haven asset and inflation hedge remains crucial. With central banks continuing to adjust monetary policies and geopolitical tensions remaining elevated, gold provides portfolio insurance against adverse macroeconomic shocks. We grew our gold equity position over 2024, especially during tax loss selling in December. Gold ETF, Barrick Gold, Newmont, Royal Gold – 8% median allocation.
Conclusion: By addressing our key concerns through our eight investment themes, we aim to achieve a balance between minimizing downside risk and having exposure to investment return. International stocks and value plays offer growth and upside potential, while baby bonds, yield plays, short-term treasuries & gold provide stability and protection. Biotech and energy investments position the portfolio to capitalize on innovation and structural trends & dislocations, ensuring resilience and long-term value creation for our investors.
Disclosures: The median theme portfolio holding discussed above is based on a composite of client household accounts and excludes other households that have specific mandates. Individual clients may and will have different portfolios based on a variety of factors including available cash at the time of purchase for specific securities, account size and client preferences/risk tolerance. Your individual account may/or will differ. The information above concerns investment/market/economic performance and scenario analysis and is for informational purposes only. It should not be considered as financial advice or relied upon for making investment decisions. Prospective return forecasting involves making assumptions about various variables and market conditions, which may or may not reflect real-world outcomes. Actual investment performance can vary significantly from hypothetical scenarios due to unforeseen factors and changing market dynamics. Past performance is not indicative of future results, and all investments carry inherent risks. The various macroeconomic charts presented above were sourced from various public sources and may not be correct; we have not tried to evaluate their data quality or verify their accuracy. Please reach out for any further information concerning sources.
