There are reasons to be concerned about private equity-- Portfolio manager explains why

Key Concepts

• Palantir (PLTR): A software company specializing in data analytics and artificial intelligence.
• Forward PE Ratio: A valuation metric that divides a company's current share price by its estimated future earnings per share.
• Forward Price to Sales Ratio: A valuation metric that divides a company's current share price by its estimated future revenue per share.
• Short Selling: A trading strategy where an investor borrows shares and sells them, hoping to buy them back later at a lower price to profit from the difference.
• Active Manager: An investment manager who actively makes decisions about buying and selling securities to outperform a benchmark index.
• Active ETFs: Exchange-Traded Funds that are actively managed, meaning the fund manager makes decisions about the fund's holdings.
• Cloud Capital: An investment firm managing active ETFs.
• AI (Artificial Intelligence): A broad field of computer science focused on creating intelligent machines that can perform tasks typically requiring human intelligence.
• Scalability: The ability of a system, network, or process to handle a growing amount of work, or its potential to be enlarged to accommodate that growth.
• Tactical Opportunities: Short-term investment strategies aimed at capitalizing on market inefficiencies or trends.
• Asymmetric Exposure: A situation where an investment has a greater potential for gains than for losses, or vice versa.
• Insulate Risk: To protect an investment portfolio from potential losses.
• Volatility: The degree of variation of a trading price series over time, usually measured by the standard deviation of logarithmic returns.
• Cloud Hedged Equity ETF (CBLS): An ETF that aims to provide exposure to equity markets while hedging against downside risk.
• Long Book: The portion of an investment portfolio that holds long positions (assets expected to increase in value).
• Short Book: The portion of an investment portfolio that holds short positions (assets expected to decrease in value).
• Net Exposure: The difference between the total value of long positions and the total value of short positions in a portfolio, expressed as a percentage of the portfolio's total value.
• Themes: Investment strategies focused on specific sectors, trends, or technologies.
• Multi-Year Duration: Investments or themes expected to be relevant and profitable over several years.
• Select Equity ETF: An ETF that primarily holds long positions in selected equities.
• Consumer Spending: The total money spent on goods and services by households.
• Defensive Company: A company whose business is less sensitive to economic downturns, often providing essential goods or services.
• Derivatives of the AI Play: Companies or sectors that benefit indirectly from the growth of AI.
• Computational Capacity: The ability of a computer system to perform calculations and process data.
• Semiconductor Chip: An electronic component that is the fundamental building block of modern electronics.
• Data Centers: Facilities that house computer systems and associated components, such as telecommunications and storage systems.
• CAPEX Spend (Capital Expenditure): Funds used by a company to acquire, upgrade, and maintain physical assets such as property, buildings, technology, or equipment.
• Private Capital: Investments in companies that are not publicly traded on a stock exchange.
• Private Equity: Investment funds that are not traded on public exchanges.
• Apollo and Blackstone: Major alternative investment management firms.
• Financial Companies: Companies involved in the business of dealing with financial and monetary transactions, such as deposits, loans, investments, and currency exchange.
• Risk-Reward: The potential return on an investment relative to the risk taken.

Palantir Short Position and Active Management Strategy

Vince LaRusso of Cloud Capital discusses their recent short position on Palantir (PLTR). He highlights Palantir's extremely high valuation metrics, citing a forward PE ratio of 188 and a forward price-to-sales ratio of 116, which many consider indicative of overvaluation. Despite this, LaRusso explains that as active managers, they took a tactical opportunity to short Palantir. This short position was not a long-term conviction but rather a strategy to protect capital and manage volatility during potential market corrections. LaRusso emphasizes that they "covered that position," meaning they closed out the short trade, as it served its purpose of insulating risk. He acknowledges the impressive business created by Alex Karp and the long-term opportunity in AI, but stresses the importance of identifying companies "asymmetrically exposed to the downside" for shorting purposes.

Cloud Hedged Equity ETF (CBLS) and Investment Philosophy

LaRusso then delves into the Cloud Hedged Equity ETF (CBLS), explaining its strategy. He clarifies that CBLS is a hedged equity strategy with both a long book and a short book. The selection process is driven by fundamental research, starting with a macro view of profit cycles. Cloud Capital is currently bullish on the market due to technological innovation, particularly AI. This bullish stance influences their net exposure, which typically ranges from 30-70% and is skewed towards the higher end.

He identifies AI as a compelling multi-year theme that drives many of their holdings. Examples of companies in their portfolio include NVIDIA, a key player in AI's computational capacity through its semiconductor chips, and Redfin, which is benefiting from AI tailwinds in user engagement and monetization. TJX is also mentioned as a more defensive company with strong operators, indicating a diversified approach within the ETF.

Select Equity ETF and Consumer Sentiment

Charles inquires about the Select Equity ETF, which is a long-only fund. LaRusso notes the presence of names like Reddit and TJX in this ETF as well. He addresses the question of consumer health by suggesting that there are "two different economies." While the AI theme is driving innovation and growth for companies like Reddit, which is monetizing its user base more effectively through AI, TJX represents a more defensive play, appealing to consumers in a potentially more challenging economic environment.

AI Derivatives and CAPEX Spend

The discussion touches upon companies that benefit indirectly from the AI boom, referred to as "derivatives of the AI play." NVIDIA is presented as the primary example, providing the essential semiconductor chips and computational power. LaRusso explains that other companies in their portfolio will benefit from the increased capital expenditure (CAPEX) spend associated with building and fueling data centers required for AI infrastructure.

Concerns Regarding Private Equity and Credit

Finally, LaRusso addresses concerns about the private capital and private equity markets, noting the presence of firms like Apollo and Blackstone. He acknowledges that there are reasons for concern, even though many companies within these sectors are healthy and growing. He points out that stocks are "breaking down big time" from "pretty lofty valuations" following significant asset growth. This leads back to their core strategy of seeking asymmetric risk-reward opportunities, both on the upside for their long book and on the downside for their short book, with private credit-type names beginning to show signs of weakness.

Synthesis/Conclusion

The discussion highlights Cloud Capital's active management approach, utilizing both long and short positions to navigate market opportunities and manage risk. Their investment strategy is driven by fundamental research, a macro view, and a focus on compelling themes like AI. While bullish on technological innovation, they remain vigilant in identifying potential downside risks, as demonstrated by their tactical short on Palantir. The conversation also touches upon the nuanced economic landscape, with distinct drivers for growth in tech-centric companies versus more defensive consumer-facing businesses. The increasing CAPEX spend related to AI infrastructure and potential vulnerabilities in the private equity and credit markets are also key areas of focus for their risk management.