SPRX - Spear Advisors Q1 2023 Fund Letter
2023-04-27 05:15:00 ET
Summary
- SPEAR is a fundamental asset manager and ETF issuer specializing in investments in industrial technology value chains.
- Spear Alpha ETF (SPRX) was up 25.5% in 1Q23 compared to the S&P 500 up 7.5% and the Nasdaq Composite up 17.1%.
- We believe that consumer technologies drove the prior tech cycle (streaming, adds, social media), and B2B technology will drive the next one.
- We protect the downside by investing in proven business models ($1bn+ in revenues), positive Free Cash Flow (FCF), unique market position, and strong management teams.
Dear Reader,
Spear Alpha ETF ( SPRX ) was up 25.5% in 1Q23 compared to the S&P 500 up 7.5% and the Nasdaq Composite up 17.1%.
After a difficult 2022, we are starting to see some signs of stabilization from some of our early cycle focus areas (such as semiconductors), which are considered to be leading indicators for other tech sub-sectors. With interest rates range-bound between 3.5% - 4.0% (10Y Treasury), the set up for technology is significantly more favorable this year.
Outside of semis, which have started to recover, many attractive sub-sectors (e.g., cybersecurity, cloud infrastructure, etc.) are still trading near lows (down 60-70% from their peaks).
Performance contributors
Outperformers: two main areas drove the outperformance this quarter:
- Semiconductors/Artificial Intelligence ((AI)) was our best performing sector. In addition to the early cycle aspect in semis, developments in AI provided a meaningful tailwind for this space. Nvidia ( NVDA ) was our top performer, up 90% for the quarter. Nvidia is uniquely positioned in AI by providing both the hardware and software architecture used for AI model training and inference, and frameworks for building AI applications.
- Enterprise Software benefited from cost cuts and stabilizing fundamentals. After a challenging 2022, many companies were able to right size their operations and continue to benefit from the strong secular trends of enterprise digitalization. HubSpot ( HUBS ), a leading CRM system for SMBs, was up 48%, and Shopify ( SHOP ), a leading operating system for retailers was up 38% in 1Q23. Both companies reduced their workforce by 7% and 10% respectively, while growing revenues at a double-digit rate.
Underperformers: Our underperformers this quarter were companies levered to enterprise spending such as cloud infrastructure and cybersecurity. Enterprise spend recovery generally lags semis by 6 months. While still experiencing solid growth (30%+ topline), some of the best regarded companies in the space are facing spend optimization and experiencing extended sales cycles.
- Cybersecurity leader Zscaler ( ZS ) has significantly underperformed this year, up only 6% in 1Q23, as investors were underwhelmed by the company's guidance, citing extended sales cycles, lower deal close rates, and staggered deals.
- Cloud infrastructure leader Snowflake ( SNOW ) also underperformed, up only 14% in 1Q23, as the company pointed out that its clients are going through an optimization phase, rather than expansion, purchasing only the minimum credits to get through the quarter.
During the quarter, we added a new position in AMD , another semi-conductor manufacturer, which we expect to gain market share, as our channel checks indicate that Nvidia's hardware is close to sold-out. AI is in the very early innings of adoption, and the hardware requirements associated with training and running models are immense.
Despite the recent outperformance, the majority of our holdings, specifically ones that are levered to enterprise spending, are still down 50–80% from their peak levels, highlighting the severity of the tech pullback and the runway ahead. We believe that while investors have started pricing in the AI hardware opportunity, the potential opportunity for cybersecurity and data/compute management created by AI is significantly underappreciated.
Portfolio composition and risk management
We believe that consumer technologies drove the prior tech cycle (streaming, adds, social media), and B2B technology will drive the next one. Our current portfolio is comprised of four core areas:
- Cybersecurity (22%) benefiting from a major technology shift from changes in enterprise infrastructure and continuous evolution of threats (with AI adding an incremental layer of risk). Our largest holdings are: Zscaler, a leader in "zero trust" network security; CrowdStrike ( CRWD ), a leader in endpoint security; and relatively smaller, Palo Alto Networks ( PANW ) a leading cybersecurity platform. All three companies have significant scale ($1bn+ in revenues) and are profitable.
- Cloud Infrastructure (21%) benefiting from massive growth in data and compute/storage requirements. Our largest holdings are: Cloudflare ( NET ), an integrated global cloud network, and Snowflake, cloud-computing based data warehousing company. Both companies have been growing at 40-50%+ topline growth rates, while being FCF positive.
- Artificial Intelligence Hardware (21%) benefiting from new developments in generative AI. Our largest holdings are Nvidia, Marvell ( MRVL ), and AMD, which we believe, are best positioned to benefit from the positive trends in high performance computing, accelerated by AI adoption.
- Enterprise Software (16%) benefiting from ongoing need to transform processes in traditional industries; from sales/CRM solutions that enable faster revenue growth, to solutions that help to optimize operations, which will ultimately result in higher margins. Our largest holdings are Shopify and HubSpot. Enterprise software is sold on subscription basis and is therefore relatively more resilient through economic downturns.
During periods of market declines we generally add risk, as we are trying to capitalize on inefficiencies created by the market.
The differentiated aspect of our strategy is to manage risk by increasing our asset turnover and idea velocity, rather than reducing risk, which can come at the expense of long-term returns. Increased asset turnover for us means taking profits in outperforming areas (e.g., lithium mining) and re-deploying them to underperforming areas (e.g., hard hit technology). Increased idea velocity means increasing the pace of idea generation with the goal of eliminating lower conviction ideas. Consequently, we protect the downside by investing in proven business models ($1bn+ in revenues), positive Free Cash Flow (FCF), unique market position, and strong management teams.
We aspire to perform in-line with diversified indices on the downside, and generate differentiated performance on the upside, given our concentrated portfolio of investments.
Frequently Asked QuestionsFew points on liquidity and market pricing related to ETFs that may be helpful based on frequently asked questions: Liquidity. The liquidity of an ETF is determined by the underlying holdings, not by the size ((AUM)) or volume traded of the ETF itself. The ETF is backed by the assets it holds and market makers constantly create/redeem shares. Market Makers. When investors buy/and sell shares they often (but not always) buy/sell directly from the market maker who has created the shares and holds them in inventory. This ensures that there is always a market to buy/sell ETFs, rather than having to match a buyer with a seller (as it is for equities). Market pricing. The price of the ETF changes constantly and moves with the underlying securities. To get the most accurate pricing when buying/selling an ETF investor should look at the actual bid/ask quote and spread. The ETF shares are backed by the fund's holdings which in our case are custodied at US Bank. Tax Efficiency: Due to their ability to exchange shares in-kind, ETFs can be more tax efficient than hedge funds or mutual funds. For more info visit our website spear-funds.com . |
DISCLOSURES:© 2022, Spear Advisors LLC (“SPEAR” ”SPEAR Invest”). Investors should consider the investment objectives, risks, charges and expenses carefully before investing. For a prospectus or summary prospectus with this and other information about the Fund, please call (888) 123-4589 or visit our website at www.spear-funds.com . Read the prospectus or summary prospectus carefully before investing. “Alpha” strategy seeks to identify investment opportunities in which the performance of a company’s stock will exceed that of the market over time. B2B stands for business-to-business. Investing involves risk including possible loss of principal. The fund is subject to both growth and value equity risk. Investing in growth companies that are based on an issuer’s future earnings may be more volatile if revenues fall short of expectations. Investing in value companies that remain unfavored or are undervalued for long periods of time could have a negative on the fund’s performance. Companies in the industrials sector may be adversely affected by changes in government regulation, world events, economic conditions, environmental damages, product liability claims and exchange rates. Technology, Space, Robotics and Automation companies are particularly vulnerable to rapid changes in product cycles, obsolescence, government regulation and competition, both domestically and internationally, which may have an adverse effect on growth and profit margins. Market or economic factors impacting these companies that rely heavily on technological advances could have a major effect on the value of the Fund’s investments. SPRX is non-diversified and may invest in a greater percentage of its assets in securities of an issuer in the industrial or technology sectors. An adverse event to an issuer in the industry may negatively impact the fund’s performance. Applying ESG (Environmental, Social, Governance) sustainability criteria to the investment process may exclude securities of certain issuers for non-investment reasons and therefore the Fund may forgo available market opportunities. The Fund is a recently organized and has a limited track record to base an investment decision. Foreside Fund Services, LLC, distributor. |
Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.
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Spear Advisors Q1 2023 Fund Letter