Lions Bay Q1 2025 Commentary - Discipline, Flexibility, and Performance Amid Market Shock

For the first quarter of 2025, the Lions Bay Fund returned +3.72%, while the S&P declined by -4.27%. In the first week of Q2, global financial markets suffered a violent sell-off, with the S&P 500 plunging 10.5% in two days, its 6^th largest two-day decline on record¹, leaving it -13.42% for the year as of the April 4^th close.  Our hedging strategy performed well last week, and as of April 4^th, the Fund is up an estimated +0.25% for the month and is outperforming the S&P 500 by over +17% year to date.

Before digging into the commentary, I’d like to express my sincere gratitude for the dedicated work of our operations team over the past few weeks.  Sharv, Nick and Andy have worked tirelessly this year to enable an exceptionally high level of trading volume from Lions Bay, frequently spending late nights processing after-hours trades to manage risk in such a dynamic news environment.  Lions Bay is lucky to have such a deep and talented bench of professionals to support it.

Liberation Day… for Volatility Traders

While we certainly expected an elevated level of market volatility to accompany the new U.S. administration (we even had a slide titled “Making Volatility Great Again” in our fall marketing deck), we did not forecast the VIX² setting its highest closing level since the pandemic during the First 100 Days of the presidency.

Following two years of complacency, we believe that we have now entered a new regime of sustained higher volatility, closer to the markets of 1996-2002, 2007-2012 or 2020-2022 that you can observe in the 30-year chart of the VIX below.

A higher volatility regime is good news for Lions Bay investors, as our strategy is designed to profit from the opportunities such an environment creates.

VIX INDEX – 30 YEAR CHART

Lions Bay Portfolio Review by Strategy

We concluded our last quarterly letter with the following commentary:

“We see a pro-growth economic backdrop that will benefit our core portfolio balanced against a geopolitical landscape conducive to bouts of volatility which should lead to profitable opportunities for our active trading and hedging portfolio.”

While the latter part of that sentence played out, the first part most certainly has not.  As a result, our core portfolio is considerably different than it was when we wrote to you last.  As a small and nimble fund, one of the many advantages Lions Bay enjoys is the ability to rapidly shift the composition of our investment portfolio when an investment thesis changes.

While the core portfolio helped drive a strong return in January, for the quarter it was a drag on performance.  An exceptional quarter from our hedging portfolio and a solid quarter for our active trading portfolio were able to offset losses in the core portfolio for Q1.  We enter Q2 well situated to take advantage of compelling long-term investment opportunities we slowly see emerging in equity markets, which began to show the first signs of genuine panic selling on Friday.

Core Portfolio Review and Outlook: Not Afraid to Change Our Mind

We de-risked our core portfolio considerably during Q1.  We tell our investors that we will generally sell a core portfolio stock for three reasons:

1. The stock grows to be too large a position in our portfolio relative to our other holdings
2. Valuation of the stock begins to get stretched
3. Our investment thesis on the stock changes

In the first two cases, we will sell shares slowly.  When the third occurs, we will sell the stock very quickly.  As tariff risks escalated from posturing to reality over the course of the quarter, we chose to take a loss on a number our core portfolio holdings which we invested in under the assumption that we were entering a pro-growth economic environment. 

One of the major themes we were excited about entering the year was a resurgence in merger and acquisition activity, and made several investments in boutique investment banks levered to M&A volume such as Evercore (EVR), Moelis (MC) and PJT Partners (PJT), building these positions throughout January.  Each one of these companies reported stellar quarterly earnings results in early February, along with robust guidance, and sell sided analysts raised price targets across the board.³

Unfortunately, the positive share price reactions marked the YTD highs for each stock thus far, as the shares quickly began to sell off as tariff uncertainty led to a freeze in deal making activity.  When we began to realize that our investment thesis was no longer valid, we sold EVR entirely and meaningfully trimmed PJT and MC.  Blue Owl Capital (OWL), which we profiled in our last commentary, has also been meaningfully reduced this quarter.  We sold most of our shares in the low 20s, taking the position down from close to a 3% weight to a sub 1% weight at the end of the quarter.  We started to buy back a small position late last week, buying some shares on Friday around $16.  

We profile these changes so our investors can appreciate that we are not going to be stubborn with our investment decisions and will change our mind when the facts change.  Anchoring bias and a refusal to change views in light of new information is an investment sin in any market, but we believe it is particularly deadly in the environment we find ourselves in today, where the conditions are rapidly changing by incredible degrees of magnitude. 

Continuing with the theme of intellectual flexibility, we have found ourselves putting capital to work in a segment of the market that we have spent countless past commentaries disparaging: large cap tech.  As you can see in the chart below, the Bloomberg Magnificent 7 Index, the stalwart of the 18-month bull market off the October 2022 lows, is down 25% year to date. That is twice the decline of the S&P 500, and it is down 16% in the last 8 days alone. 

The magnitude of the sell-off is unsurprising when you consider how crowded these stocks were among the investment community, something we’ve discussed endlessly in past letters. We believe that crowding has unwound significantly in the past 6 weeks, with these stocks acting like ATMs for deleveraging investors. 

BLOOMBERG MAGNIFICENT 7 TOTAL RETURN INDEX

During the March sell-off, we began building positions in Microsoft, Amazon, Meta and Alphabet.  These businesses do face cyclicality in terms of consumer discretionary and enterprise spending as well as advertising budgets, and will suffer in a deep recession, but with significant free cash flow generation, deep competitive advantages through massive platforms and with pristine balance sheets, these companies will survive and grow through a recession.  Furthermore, they don’t face many of the tariff risks that are going to challenge most American businesses.  We never disliked these companies – we just disliked their shares.

Perhaps what we like most about these stocks for this moment in time is that they are incredibly liquid and very easy to hedge, with a highly liquid options that have weekly expiries.  In the chaotic environment we are in, the ability to dynamically manage the risk of a large segment of our core portfolio can be incredibly valuable, as we will highlight later in our commentary.

In the quarter ahead, we will continue to hunt for new core portfolio ideas and opportunities to slowly deploy more of our cash into our existing holdings.  While we are closer today than we were on March 31^st, the market Is not yet pricing in a recession.  We don’t expect to be deploying capital in an aggressive way until we see some shares discounting a much more dire economic picture.  We expect the Q1 reporting season to be treacherous, as CFO’s have a free pass to slash full year earnings guidance or pull guidance entirely.  We are well positioned to take advantage of the long-term investment opportunities which we expect to emerge from this environment. 

Hedging Portfolio Review and Outlook: Managing Both Systemic and Idiosyncratic Risk

The lions share of our hedging gains this year have come from index linked products, primarily those linked to the ETFs of the S&P 500 (SPY) and the Nasdaq (QQQ) and to a lesser extent, the Russell 2000 Small Cap Index (IWM).  We consider these our ‘systemic’ hedges. The hedging portfolio exists to protect the portfolio from significant market shocks that can rock the entire financial market.  These systemic hedges served us well through the pandemic of 2020, the inflation shock in 2022, and they continue to do so during the current market shock.

In addition to systemic hedges that hedge against broad market declines, this year we have benefited from more targeted hedges, aimed at protecting significant idiosyncratic risks in our core portfolio. 

Once we began to get concerned about a slowdown in the M&A cycle, in addition to selling some core portfolio names, we bought a series of put options on a large bulge bracket investment bank to help mitigate some of the risk to our largest core portfolio holding, Houlihan Lokey. 

Starting with an initial position in the March 21^st expiry puts, we rolled these several times before making the decision to use some of the realized profits to extend this hedge out to May.  All told, our total gains from our short exposure to this large investment bank through March 21^st and May 16^th put options total $4.31 million as of the market close on April 4^th.  These gains help offset the unrealized losses we have experienced this year in Houlihan, while putting us in a strong position to buy more shares as they continue to get cheaper.

As we mentioned in our Core Portfolio Review, during the March sell-off we began to add to our position in Microsoft, Amazon and Meta.  Beyond their resilient business models, one of the things that attracted us to these stocks was the ability to easily hedge them.  Ahead of the tariff announcement, we went out to the April 11^th expiry options and bought puts on all three names.  As the market plunged last week, these hedges in aggregate generated approximately $1.74 million in total profits, of which $1.12 million have been realized.  These profits were able to offset most of the unrealized declines in these holdings and provides us some dry powder to take advantage of the emerging panic selling.

Active Trading Portfolio: Chasing Waterfalls

While equities have fallen in a straight line for the past 2 day -10% move, they will not continue to do so forever.  Bear markets are characterized by vicious rallies, creating a decline that looks much more like a waterfall than an elevator on price charts.  This is one of the reasons why single stock short selling can be so deadly, and why we avoid managing risk in that manner.  The table below of the top 20 best 1 day returns for the Nasdaq from 1990-2021 will show this.

RANKED NASDAQ 100 ONE DAY % RETURNS

Take a closer look at the dates in that table.  These days did not occur during the great Nasdaq bull markets.  Almost every one of them is sprinkled among the ugliest bear markets for the index. 

As the S&P 500 rapidly gets ever closer to entering a formal bear market (Nasdaq is already there), we believe this type of waterfall price action will create many compelling opportunities for the Active Trading portfolio of Lions Bay. 

One of the reasons the Fund performed so well during the 2022 bear market was that we capitalized on the inefficiencies created by powerful countertrend rallies in March and August of that year.  These rallies provide a great opportunity to reset hedges and monetize short term trading gains.  Furthermore, we will be opportunistically picking away at ‘right-tail’ trades, either through liquid ETFs or listed equity call options to add some exposure to a violent price move higher.

We want to close our letter with a reminder on the perils of downside compounding.  We know that through the six-and-a-half-years of the Fund operating, Lions Bay has endured periods of quiet performance during euphoric markets.  The events of the past 8 weeks are a reminder of how quickly a bear market can erode gains and reiterates why avoiding downside is of much greater value of capturing upside. 

As of the February 28^th 2025 close, the S&P 500 was sitting on a +19.02% 12 month return, +42.49% three year return and a total return of +133.36% since August 16^th 2018, the inception date of Lions Bay. As of the close of Friday April 4^th, those numbers are -0.10% for 12 months, +15.9% three years, and +99.16% since the inception of Lions Bay.  

For contrast, the since inception returns for Lions Bay have only declined from +186.15% on Feb 28^th to an estimated +185% at the April 4^th close.

We wish all our clients a safe and healthy start to Spring. As always, please do not hesitate to reach out with any questions, comments or ideas.  We look forward to reporting to you again at the end of Q2. 

[1] Behind 10/19/1987, 10/20/1987, 3/12/2020, 11/20/2008 and 11/06/2008
[2] The VIX Index, often referred to as the ‘fear index’, is a financial benchmark that measures the expected volatility of the S&P 500 Index[
[3] MC reported EPS of $1.15 vs. 0.45, EVR $3.30 vs $2.84 and PJT $1.86 vs. 1.13. 

Disclaimer

This Commentary expresses the views of the author as of the date indicated and such views are subject to change without notice. Wealhouse has no duty or obligation to update the information contained herein. This Commentary is being made available for educational purposes only and should not be used for any other purpose. The information contained herein does not constitute and should not be construed as an offering of advisory services or an offer to sell or solicitation to buy any securities or related financial instruments in any jurisdiction. Certain information contained herein concerning economic trends and performance is based on or derived from information provided by independent third-party sources. Wealhouse believes that the sources from which such information has been obtained are reliable; however, it cannot guarantee the accuracy of such information and has not independently verified the accuracy or completeness of such information or the assumptions on which such information is based.