This is the 3Q24 quarterly update for our flagship fund, Spear Alpha ETF (NASDAQ:SPRX). In these quarterly letters we share our performance highlights and trends that are shaping our investment approach.
SPRX was down 3.48% in 3Q24 compared to the S&P 500, up 5.89%, and the Nasdaq Composite, up 2.76%.
The third quarter of 2024 was pretty brutal with macro headwinds, such as the carry trade unwind, election uncertainty and interest rate concerns dominating the headlines. In addition, idiosyncratic events such as the Crowdstrike (NASDAQ:CRWD) incident negatively affected our performance. We were pleased with how we navigated though these headwinds and positioned ourselves to capture the next wave - more details in the risk management section below.
With many of these headwinds dissipating, we are starting to see underlying growth pick up across several areas. We have now shifted our focus to offence from defense and added several attractive opportunities though the year.
Summary:
- Signs of growth pick up across several areas, despite higher interest rates and higher expected inflation.
- Uncertainty created attractive opportunities in 1Q-3Q24 - upside is broadening from AI Hardware to other areas including AI Applications.
- Shifting to offense - buy any dip.
Our base case assumption of higher inflation and higher for longer interest rates, which resulted in 2+ years of muted macro growth, hasn't changed. What's new?
We are just now starting to see growth pick up across several areas.
1. In Hardware, Nvidia (NASDAQ:NVDA) was the only company with an outsized revenue growth in 1H24. However, the upside is now broadening to custom chips, as the Cloud Service Providers (CSPs) are entering the space, networking and power generation, as new data centers require incremental physical infrastructure. As a result, earnings are revised upwards.
2. On the Data Infrastructure side, new business booked (net new ARR) has been negative for several quarters now, even for the companies growing revenues at 20%+. This metric just inflected positively this quarter.
3. In AI Applications, we are just starting to see use-cases that can have a transformational impact on the world make progress. While it is too early to see this in the earnings, several companies are hitting meaningful technology milestones.
The risk-off environment from the first half of the year continued to the third quarter, but the set up significantly reversed as we entered 4Q24. With the removal of the election uncertainty we are noting significant uptick in business confidence. With growth picking up, it is reasonable to assume that inflation will not subside, but from the market perspective growth + inflation is much better than stagflation (i.e., no growth + inflation) as corporate earnings act as an inflation hedge.
Regardless of the macro, there is no question that we are in the early innings of the next technology cycle amplified by AI.
What gives us confidence looking into next year:
- Capex spending cycle is broadening. While the first wave of hardware investment in AI was focused on processors which went into existing infrastructure, the newer and more powerful system (such as Nvidia's Blackwell DGX) require new data centers and physical infrastructure.
- Emerging AI Applications. While 2024 was the year for hardware, we are starting to get a glimpse of sizable AI applications. The early applications were mostly focused on productivity improvement (e.g. copilot, sales productivity tools etc.) but we are starting to find applications that have been impossible to progress due to compute limitations and are now realizing a step change in performance with accelerated computing (e.g. autonomous driving, quantum computing).
- Attractive valuations. Valuations in certain areas have expanded but the encouraging angle during this up-cycle is that the upside has been driven by earnings rather than valuation expansion. Valuations for mid-caps (
Performance contributors and commentary
The biggest changes to our portfolio over the course of this year have been:
- Expanding our data center hardware trade to tangential areas across the value chain such as networking and power generation
- Expanding into the application layer
Here glimpse of our current portfolio and performance contributors:
Data Center Hardware had mixed performance during the quarter, with processors underperforming and power generation outperforming.
Processors: Nvidia (NVDA) outperformed the rest of our portfolio and Marvell (NASDAQ:MRVL) and AMD (NASDAQ:AMD) significantly underperformed. We have been adding to our Marvell position but cut our exposure to AMD as our research indicated that custom chips are gaining significantly more traction.
Power Generation & Materials: Constellation Energy (NASDAQ:CEG) was the top performer for the quarter post the announcement of a re-opening of the Three Mile Island nuclear plant. Power generation and the grid have been underinvested for over 20+ years, and we expect a meaningful cycle ahead. As a result, we have continued to invest in this area and added two relatively new positions in GE Vernova (NYSE:GEV) (GEV) and Vistra Energy (NYSE:VST).
Networking has been another area of focus as we believe it presents a large opportunity. Here, we grew our position in Arista Networks (NYSE:ANET) and more recently added new smaller positions in Astera Labs (NASDAQ:ALAB) (ALAB) and Credo Technology (NASDAQ:CRDO).
Data Infrastructure and Cybersecurity has been a meaningful underperformer this year. Software, more broadly, had a difficult year and companies levered to enterprise spending had slower than expected earnings growth. In addition, we were negatively impacted by the Crowdstrike incident during the quarter.
We continue to have significant exposure to this area as we believe there is long-term upside, but we are managing the risk very actively as this is the one area of technology that is disproportionately affected by interest rates. Our largest investments Snowflake (NYSE:SNOW), Cloudflare (NYSE:NET) and Datadog (NASDAQ:DDOG) in Data Infrastructure, and Zscaler (NASDAQ:ZS) in Cybersecurity.
AI Applications. Lastly AI Applications are starting to gain significant traction. Problems that were unsolvable for 10+ years are now able to use accelerated computing. In 2024 our exposure to AI Applications was mostly in the productivity improvement area with holdings like HubSpot (NYSE:HUBS) and Shopify (NYSE:SHOP). We have taken some profit here and re-deployed it to newer areas such as Autonomy and Quantum Computing.
Tesla (NASDAQ:TSLA) is our top pick here as the company transitions from a cyclical EV play to full autonomy and robo-taxis. We believe that regulatory support in addition to step-change improvement in the safety of the technology will result is significant scale and upside for the stock.
How do we manage risk?
We have two main tools for risk management:
1. We increase our idea velocity: during periods of consolidation, we increase the pace of generating new ideas (e.g., in the past 9 months, we have increased our exposure further down the data center value chain, specifically expanding to areas "outside of the rack" including networking and energy generation).
2. We take profits on outperformers and cut/reduce losers. The most important aspect of this is that we try to maintain the same level of risk so that when the market turns to risk-on, we are positioned to capture the benefit.
Fundamental active strategies, in general, perform better in a risk-on environment as investors are looking to allocate to ideas that capture alpha and broaden their exposure beyond just tracking broader market.
We continue to manage risk actively and asses the potential risk/reward of each individual holding, incorporating the trajectory of earnings and valuation. 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 Questions
Few 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 investors 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.
For a Fund prospectus, standardized performance, and a complete list of holdings, visit spear-funds.com.
Disclosure: The performance data quoted represents past performance and does not guarantee future results. The investment return and principal value of an investment will fluctuate so that an investor’s shares, when sold or redeemed, may be worth more or less than their original cost and current performance may be lower or higher than the performance quoted. For performance current to the most recent month-end please call 1-833-340-7222.