Q1 2024: Inner Scorecard

Welcome to my first quarterly letter of 2024. 

To new and old readers alike, a friendly reminder: at Interconnected, I run a long-only equity portfolio that is laser-focused on investing in the “picks and shovels” of the interconnected global digital AI economy. I draw on my technology business operator's experience and geopolitical antennas to bring an edge to how I assess a tech company’s rhythm and prospects in a constantly changing world.  

Going forward, I plan to write a quarterly performance update letter, like this one, to be published on the 1st or 2nd day of the second month following the end of the previous quarter (i.e. Q1 ends on March 31, so Q1 letter goes out on either May 1st or 2nd). I chose this rhythm, because it usually takes me a month to fully process and reflect on the previous quarter, in order to share something of value worth reading. I also don’t want to over-emphasize the significance of a quarter by not letting enough time pass to understand it. As a long-term investor and former operator, three months is a tiny, if not arbitrary, quantum of time in the grand scheme of things. 

Before I discuss last quarter’s performance, a quick update on last year’s. My 2023 annual performance was examined and verified by a third-party independent accounting firm (Spicer Jeffries). The result is 170.13%, net of all management and performance fees. The report is available upon request for any interested capital allocator. You can also read about my reflection of 2023 in my annual letter. 

Here is my Q1 2024 performance, YTD performance (through April 30, day before publishing this letter), and comparisons to three relevant benchmarks. 

1  My past experiences include: senior leadership position at GitHub (the world’s largest developer and open source technology platform, now owned by Microsoft), a unicorn database startup, early stage VC, and the White House and Department of Commerce during the Obama administration. I studied law and computer science at Stanford; international relations at Brown. 

2 Through March 31, 2024. Unaudited.

3 Through April 30, 2024. Unaudited.

Top holdings in alphabetical order (as of March 31, 2024):

• ALIBABA GROUP HOLDING (Call Options)

• GITLAB INC

• VERTIV HOLDINGS

• ZOOM VIDEO COMMUNICATIONS

I invest strictly within a tight circle of competence – cloud computing infrastructure, DevOps, open source, semiconductors. My process is value-oriented and bottoms-up, starting from the technology, then the business model, then the people and management, and ultimately, perhaps most importantly, the price – marrying technological fundamentals with financial fundamentals.

Inner Scorecard

One notion that encouraged me to leave my rather comfortable job in tech last year to start Interconnected Capital is what Warren Buffett calls the Inner Scorecard. Over the last five years, I have thought deeply about what goes on my inner scorecard, both personally and professionally.

Personally, marrying a kind, loving, and moral person with whom to build a family is high on the scorecard, which luckily I was able to do just a few weeks ago. Health-wise, I want to maintain both mental calmness and physical competitiveness for as long as my body can handle it, and am working towards this by doing CrossFit 3-4 times a week and therapy sessions regularly. As for investing, my inner scorecard is 30% average annual return for 30 years (or “30 for 30”). Last year would be the first of these 30 years; 29 more years to go!

Having thought through my inner scorecard before starting my professional investing journey turned out to be especially helpful psychologically in Q1. Everything in AI was going up and up, fueled also by (false) hopes of multiple interest rate cuts. As a value-oriented, long-term investor, a lot of prices started to not make sense. I reminded myself of what’s on my inner scorecard, in order to resist chasing the crowd and deviating from my approach. I was at peace with the reality that my investing strategy will mean when the market gets too hot, I will more likely underperform a bit in the short-term. As a competitive person, it does not make underperformance, even a temporary one, easy to swallow, though it does make that reality easier to understand (and withstand).

In early March, I was invited to speak at a webinar hosted by a wonderful investing community, World of Allocators, to talk about the intersections of AI, tech, and geopolitics with many family offices. During the session, one attendee pointedly asked me how I can maintain my performance when the whole market is all about growth and momentum. I shared with her my investing inner scorecard – 30 for 30 – and preached the virtues of patience and price discipline. 

Depending on when you read this letter, the red hot market has already cooled down somewhat. Depending who you ask, a projection of six Fed rate cuts has all of a sudden turned into 2, 0, or reversed to a rate hike! Such is the way of Mr. Market. And navigating through these huge volatilities require an inner scorecard to buttress discipline. My journey with GitLab illustrates well this discipline I’m honing.   

Journey with GitLab

GitLab is the oldest member of my young portfolio. I got to know GitLab, as a budding star in the world of open source software companies, since it was a Series C private company. Besides its eye popping topline growth at the time, GitLab had a few interesting “quirks” that made it stand out among a sea of look-alike enterprise software startups – all remote from day one, extremely transparent culture, buyer-based open core business model, and lightning execution speed to stitch multiple DevOps tools to work best for large enterprises.

When it became a public company in October 2021, I began tracking its product (as an occasional user) and business even more closely. Like many software companies that IPO’ed at that time, it was very expensive from the get-go. It took many rate hikes, massive tech industry layoffs (a fate GitLab did not escape), the unfortunate personal news of its CEO battling bone cancer (thankfully, he is doing much better now), and, ironically, the emergence of AI-powered coding product and the market’s (temporary) judgment that GitLab is a loser in this battle (I disagreed) that presented opportunities to buy at a fair price. 

Here is a chart of GitLab over the last 18 months, when I bought to build a position (blue circles), and when I sold some of that position (green circles). 

The two selling moments were painful – done entirely for either tax reasons or to fund another idea. As a small, cash-strapped fund, selling (reluctantly) to fund another opportunity is the unfortunate set up for the foreseeable future, which I’m at peace with. What’s more instructive to observe is that while the price of GitLab snapped back after my initial purchases and, almost right away, started gaining momentum in the generative AI craze, I didn't buy more to chase the momentum, because the fundamentals became expensive again. Furthermore, even during its most recent pull back post earnings in March, which presented a tempting window to add shares, I stayed disciplined, because fundamentals are fundamentals. GitLab was expensive in my view and still is at the time of this writing. Thus, I remain in waiting mode.

As the only publicly-listed pure play in the lane of generative AI developer products, the long-term prospect of GitLab is bright, especially as more large-scale AI adoption shifts to on-prem, private cloud deployment (a huge topic I’ll save for a different day). But price matters; it always matters. The rules of the daytime game show “The Price is Right” illuminates this principle better than perhaps any business book: you can win by guessing below what something is worth (the good ol’ “one dollar bid” trick), but you always lose by guessing above. Same goes for investing.

This brief encapsulation of my journey with GitLab is mostly intended to show how I approach good companies while exercising price discipline in this volatile market. There is much more to say about the pros and cons of the company’s products, market positioning, R&D, financials, and future profitability. (If there is strong interest in a proper deep dive of GitLab, please let me know, and I’m happy to put something together.)

The entire investing and business world will be watching the Berkshire Hathaway annual meeting this weekend – the first one without Charlie Munger. I, too, will be tuning in. Over the years, I have turned this annual ritual into a meditative exercise, where I listen less for specific investment advice or market analysis, but more for principles and reminders that help balance my psychology and fortify my temperament. 

Buffett and Munger have given the world many such gifts over their decades of sharing. The Inner Scorecard is the biggest gift, among many, that I’m most grateful for. I hope it can help you too. Until next quarter…

Sincerely, 

Kevin S. Xu

Date: May 1, 2024

(You can access the original letter in a view-only Google Doc link HERE.)

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LEGAL INFORMATION AND DISCLOSURE

This letter expresses the views of the author as of the date indicated and such views are subject to change without notice. Interconnected Capital, LLC (“Interconnected”) has no duty or obligation to update the information contained herein.

Further, Interconnected makes no representation, and it should not be assumed that past investment performance is an indication of future results. Moreover, wherever there is the potential for profit there is also the possibility of loss.

This letter 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.

Interconnected 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.

All figures are unaudited. Interconnected does not undertake to update any information contained herein as a result of audit adjustments or other corrections. Past performance is not indicative of future results.

This letter, including the information contained herein, may not be copied, reproduced, republished, or posted in whole or in part, in any form without the prior written consent of Interconnected.