Dear Partners,

For the month of June, Caravel returned -2.06% compared to -0.22% for the benchmark (-0.95% for the S&P 500 & +0.50% for the SPTSX). This brings year-to-date total net return to +9.09% for the fund and +10.86% for the benchmark, respectively.

A combination of factors led to the fund’s loss in June. 

The month began with a risk-on tenor. Apparent de-escalation in the Middle East caused crude oil prices to drop some 20% from the highs, and oversold interest-rate-sensitive stocks, such as those in the metals & mining sector, began to show signs of life. We covered shorts in the first two weeks of June in these sectors, which we held to reduce our overall commodity exposure. These moves proved to be premature in two ways.

Firstly, on June 17^th Kevin Warsh presided over his first FOMC meeting as the new Chairman of the Federal Reserve. In his subsequent press conference, his comments were read as ‘hawkish’ relative to market expectations, meaning investors began to factor in an increased likelihood of higher interest rate policy in response to persistent inflation levels. As we have written in the past, interest rate hikes would be directly in conflict with President Trump’s economic agenda. In fact, when Warsh became Trump’s nominee, most pundits pointed to his guiding principles (namely a low-rate bias) as being highly aligned with Trump’s own, and therefore making him a logical choice by the President. We were, and remain, subscribers to this belief. Though we have re-established hedges to reduce our overall metals exposure in the short-term as the market chops through the typical ‘summer doldrums’, characterized by reduced trading liquidity and issuer activity, we are on the lookout for opportunities to reduce our short exposure when we feel the bottom is likely in. We believe the current market expectations of a renewed rate hiking cycle are unlikely to materialize without a significant re-acceleration in inflation that does not adversely impact economic growth, which we see as unlikely at present.  Albeit cautiously, we have positioned the portfolio to take advantage of what we believe will be a change in sentiment in the market on this topic. We would classify this view as a ‘strong opinion loosely held,’ and if the facts change, we will not hesitate to change our minds.

Secondly, as of the time of writing, the ceasefire between the United States and Iran seems to have failed. Oil has risen 30% off the lows, but remains well below its peak levels seen in March/April. We are monitoring these developments carefully, and don’t envision making aggressive changes to our asset allocation until we have more clarity on the likely path forward for this destructive conflict.

Despite the near-term headwinds noted above, our thesis and approach remain largely the same. None of the long-term supply or demand dynamics supporting commodities like copper and uranium have changed because of geopolitical turmoil or Fed policy uncertainty. If anything, the Iran War has only further underscored the need for energy independence, a concept that initially gained steam after Russia’s invasion of Ukraine in 2022. The business cycle appears intact, which should support our investments in certain diversified industrial stocks, along with the individual performance of those businesses. We also have investments in consumer, healthcare, and financial stocks that we expect to perform well over the medium term. All told, we have increased our non-resource net equity exposure to ~20% of net assets, while our metals (12%) and energy (3%) net exposures sit near the low end of their range over the past several years. We remain active in merger arbitrage and liquid credit, where we have allocated 25% and 20% of assets, respectively.  We expect our allocation to merger arb to increase from current levels once we get through the slight seasonality effect we often see in the summer, specifically lighter deal flow. For the first time in over a year, our cash position exceeds 15% of net assets. We typically raise cash in times when we feel visibility is low, akin to slowing down your car when driving through a rainstorm. This enables us to redeploy cash aggressively when conditions improve.

In the long term, we believe the only chance developed countries have to overcome their high sovereign debt levels is through a combination of high growth and (some) inflation. Recent attempts at fiscal austerity, such as the US’s Department of Government Efficiency (D.O.G.E.), seem to have failed despite their understandable aims. The fact remains, populist governments are unlikely to cut major programs relied on by current voters to protect the interests of future ones. Although the idea of sacrifice can be powerful, we don’t believe drastic policy changes, such as amendments to Social Security, will garner enough support to be implemented in countries like the US. This leaves few options for policymakers. We think that manufacturing a recession to combat inflation would be an unforced and intolerable error, and as such we are comfortable with a divergent view than that which is currently held by market consensus. However, there is an old saying we abide by - ‘the market can stay wrong longer than you can stay in business.’ As such, rather than try to catch a falling knife, we are waiting patiently before we begin to press our bets again. We expect this all to play out relatively quickly and are excited by the prospects of the second half of the year.

We thank you for your continued support,

Jack and Glen