To our Partners,
It has been an uplifting start to 2019 as the US equities market jumped 18% following its fifth worst quarterly drawdown since 1926. The last 9 months of market volatility are a recent example of our inability to predict what the market is going to do in the short term. Will we be up another 18% in the 2nd half of 2019 or down 20% in the next quarter?
HIT Capital’s gain in 2019 was 17.1% in comparison to the S&P 500 Total Return of 18.5% and Hedge Fund Index’s gain of 7.2%. This gives HIT Capital a 12.2% compounded annual growth rate since inception.
Researching a New Offering: Peer to Peer (P2P) Investments
Rather than trying to predict the short-term swings we spent the last 6 months building upon our 2018 Peer to Peer (P2P) research. We investigated over 100 platforms and their legal structures, fees, and individual offerings.
The platform offerings were broad, ranging from equity to senior secured debt. The equity offerings are still under review, but the deep dive into P2P debt or fixed income resulted in a few actionable conclusions.
The platforms offered a multitude of fixed income investments, but the most popular were personal unsecured loans and secured real estate loans. We categorized them as such and compared their corresponding yields to low cost fixed income mutual funds.
The P2P loans seemed to be offering more competitive yields than their public market index fund equivalents. Thus we continued our deep dive and started to test and incorporate risk with an analysis of yield and credit loss.
Since P2P loans lead in yield we would expect them to lead in risk, which was the case for the P2P personal loans. Surprisingly, we found that the associated risk of credit loss in P2P real estate was lower than some of the public market, lower yielding bond funds. Once we factored in credit loss across all categories, P2P loans were still projected to return more than their public market offerings, with P2P real estate moving ahead of P2P personal loans.
We continued the deep dive into P2P real estate platforms and their associated loans through testing and investing. We invested in 100+ loans all sourced from P2P marketplaces. Thus far the research and testing are in alignment with our analysis as none of our real estate loans have defaulted, although we are still in the early days. The research estimates P2P sourced real estate loans to have the highest returns of all fixed income products studied.
As we began to focus on the best of the P2P loans, we narrowed in on senior real estate loans with the highest yield and lowest LTV (loan to value).
We haven’t yet finished our research, but we do see a potential for yields to increase further as we expand the universe of offerings to include the United Kingdom, Australia and Europe.
P2P Action Plan
Peer to Peer sourced investments were originally researched for HIT Capital but the feedback I received showed a strong demand to keep fixed income strategies separate.
Since the real estate loan yields showed above are estimated to compete with stocks and outperform bond index funds by 2x or more, we are launching HIT FI (HIT Fixed Income 1 LLC) to focus on the best of P2P real estate loans. HIT FI will be HIT Capital’s fixed income sister and will be open to new investors through the end of 2019 or until fully subscribed, whichever comes first.
The HIT FI portfolio you’d be joining currently (7/6/2019) consists of 40 loans, yielding 9.5% with an average LTV of 63%.
HIT Capital Strategy Update
The performance of our individual strategies when placed against their benchmarks were mixed over the past 6 months. Our value strategies are primarily invested in the cheaper overseas markets and the USA outperformed the world by about 4%, dragging down our relative returns. One bright spot was our 5% portfolio allocation to Russia, which we believe to be the cheapest accessible market in the world. These Russian investments were up almost 30%.
Contango, our best performing strategy to date, is still dancing like the Latin American dance within its name. The small position we own was up a nominal 45%, but only 15% when adjusted for risk. This would typically be a fantastic return, but lagged the broader US Market’s 18 percent return. Here is a quick explanation of how Contango works. For every seller in the market there is a buyer and in the Contango strategy we are the seller. The product we are selling is insurance and the buyers are fearful investors.
The insurance product is based on the volatility of the S&P 500. We earn a premium until the market takes a dive (like it did in Q4 of 2018).
The following chart helps to visualize how it works. The insurance contracts for our volatility product, the VIX are currently in Contango. This means the front month contract (July) is $15.70 and the second month contract (August) is $16.62.
We are currently selling the August contract at $16.62 and buying the July contract for $15.70 earning a $0.92 premium in the process. The contracts are for the same product just at a different period in time. This concept of the future being more expensive than the present is the definition of Contango.
The premium seen above (Contango) has historically been in our favor about 80% of the time. The chart below displays this in more detail.
Anytime the blue line is above the red line the investment is earning a premium. The premium has resulted in an unadjusted compounded return of about 40% per year and is the basis of our Contango strategy.
Beta Slippage continues to chug along turning out a premium through its daily rebalancing flaw when the market is flat or up. Since the market was up over the first half of 2019, Beta Slippage continued to do well.
HIT Capital’s 2018 audit was completed in April and your individualized tax K1 documents followed.
In 2019 we expect to see a material taxable gain at year end. The primary investment product owned in our Contango strategy had a maturity date of January 30th 2019 and as a result we had to close and transition our position. Fortunately, the product we owned had done exceedingly well over the past 5 years and this move brought about $150,000 in taxable gains that will be shared pro-rata.
It has been a strong start to 2019 and we are excited to continue strengthening our current strategies while expanding into fixed income opportunities offered up by Peer to Peer marketplaces.
If you have any questions about HIT Capital, the tax pass through, or want to take advantage of P2P sourced real estate loans through our new investment HIT FI please send me a note.
Until next time, thank you for being part of our HIT family and we wish you a happy, healthy and prosperous future.