2024 Annual Letter: Generational Company, Generational Wealth
Welcome to the 2024 annual letter of Interconnected Capital.
To new and old readers alike, a friendly reminder: I run a global technology long-only fund 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.[1] These experiences came in handy especially in the last few weeks with DeepSeek and Trump tariff shocks. More on these later in the letter.
First things first, numbers.
Below are performance numbers for Q4, all of 2024, and the average annual return spanning 2023-2024. The S&P 500, NASDAQ 100, and MSCI World are the three benchmarks I have been using as comparisons. (Note: all the Interconnected numbers below have been audited by our accounting firm, Spicer Jeffries. I began working with them to audit my performance starting in 2023. These performance numbers are assessed on a net basis, as in, after hypothetical fees.)
[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.
(If you are an accredited investor or professional capital allocator, who is interested in receiving our performance report for 2023-2024 and learning about Interconnected Capital for your capital allocation needs, you are welcome to email me at: xu.kevin@interconnectedcapital.com.)
At the start of 2024, the outlook and opportunity set was promising. My performance for the year was able to reflect that promise. Generative AI was still in its early stages of hardware infrastructure buildout with growing expectations and much room for imagination, while the steady pace in inflation reduction almost guaranteed a series of interest rate cuts at some point last year. However, as I foreshadowed in my Q3 2024 letter, Q4 was expected to experience temporary underperformance. That ended up being the case, though the portfolio has more than recovered during the first few weeks of this new year. Building a portfolio from scratch while the market repeatedly hit all-time highs, basked in the euphoria of Trump's decisive victory, only to be whipsawed by a Fed tone reversal just before the holidays, turned out to be quite a challenging task.
Portfolio positions (in random order) as of January 1, 2025:
- NEBIUS GROUP NV
- ELASTIC NV
- GITLAB INC
- KINGSOFT CLOUD HOLDINGS
- TWILIO INC
- HUT 8 CORP
- ENTERGY CORP
Tariff Proof, Grand Bargain Exposed
Now that we are at the start of 2025, the opportunity set is decidedly less rosy and plentiful compared to 2024. The “animal spirit” and near consensus view on the dominance of the US market make me concerned that most things have been priced to perfection, only waiting for the smallest of things to go wrong. DeepSeek’s entrance onto the scene was a good example.
As I was re-constructing the portfolio last quarter, the albatross of tariff went from a distinct possibility to a certainty with Trump’s electoral victory. I don’t have a strong opinion on whether tariffs will be used more as a serious policy tool to extract more government income or simply as negotiation chips. Nor would I ever risk our investors money and my own on hunches of such an unpredictable topic.
The only predictable part about Trump’s tariff doctrine is its unpredictability, by design. The distribution of outcomes could range from negotiation tactics, to territorial annexation, to shifting the primary source of US government revenue away from personal income taxes to tariff levies. The last one may sound far-fetched, but for about half of America’s lifespan, tariffs were 50% or more of the government's income. It only started to wane in the 1910s when the 16th amendment was ratified in 1913 to legalize the personal income tax. The combination of lower taxes and higher tariffs is not a sui generis idea, but simply turning back the clock.
The task of an investor, in my view, is not to guess where in this wide distribution of outcomes America will land on, but to mold our portfolio to be as tariff proof as possible, while still investing within my circle of competence. Luckily, a good proportion of my competence sits in the space of cloud infrastructure, DevOps, and software broadly, which tends to be less sensitive to tariffs directly. Meanwhile, semiconductors, networking, and the hardware side of AI’s “picks and shovels” are quite tariff sensitive and export control sensitive – both are sources of extreme volatility that will remain with us for quite some time. They are also prone to react to extraordinary pronouncements with few details, like the 500 billion (or is it 100 billion for now, or 19 + 19 + 7 billion plus future debt?) Stargate announcement, only to be pricked by an unknown (to most, though not to me) AI upstart from Hangzhou.
As the list of positions above suggest, our portfolio is focused mostly on good ol’ infrastructure cloud software companies that are consistent with my selection process, i.e.:
1) a core technology that should benefit from a secular tailwind, in this case generative AI’s widening enterprise adoption this year, especially as agents;
2) an attractive entry point with a fat margin of safety;
3) a positioning that either benefits from or avoids macro or geopolitical overhangs, in this case worldwide tariffs.
Sadly, nothing is completely immune to the downstream effects of widespread tariffs. For cloud software products, higher tariffs leading to a strong US dollar tend to cause temporary fluctuation on topline revenue by making products more “expensive”, whether the company only transacts in USD or has local currency options. It is a factor that will come into play potentially as soon as this quarter, so I will stay on top of it vigilantly.
Another factor that I’m working through is whether to be in position for a US-China grand bargain of sorts. At this moment, it is a scenario to which I only assign a high single-digit probability. Then again, if you’d asked me a few months ago to assign a probability, the answer would’ve been 0%. The upside of this unlikely event would be asymmetrically large. Trickles of signs are pointing towards a “deal” more than a “confrontation”, potentially settling into a new steady state – an unimaginable outcome since the US-China trade war first started in 2018. Then again, as an old Chinese saying goes, “The person who unties the knot has to be the person who first tied the knot” (解铃还须系铃人). That person is Trump.
Even if a deal is reached at some point during Trump’s term, I don’t expect the bilateral relationship nor the economic arrangement to return to its pre-2018 days, nor should it. I hope to have more to say on this in future letters. But for now, I’m focused on quickly updating my priors while navigating the specters of tariffs, the power of open source AI, and the potentiality of a grand bargain. That’ll be the name of the game in a tough 2025.
Generational Company, Generational Wealth
Tariff or not, grand bargain or not, Trump or not, Interconnected Capital will outlast them all. We continue to march forward in our journey of scoring 30% average annual return over a 30 year span, as we enter the third year. To accomplish this item on my inner score card, I need to find generational companies to invest in, ideally before most people realize that they are of generational potential.
My hit rate won’t be 100%. But if I get just a few right, and maintain a large enough size over a multi-year horizon, the natural outcome should be generating generational wealth for our investors. I think a few of our positions already have generational potential, not only due to the criteria in my selection process I laid out earlier, but for their demonstrated ability to survive near-death episodes that would've taken them entirely off the playing field (i.e. get acquired by a bigger competitor or PE firms or become collateral damage in a geopolitical event).
My understanding of the word “generational” took a fresh, happy turn during Christmas week, when we welcomed our son to the family. I now have an embodiment of “generational” staring at me every day, waiting for me to change his diaper or help him let out a satisfying burp.
No matter how much modeling or forecasting I do, having him has given me a clarifying, and perhaps more profound, lens to look at the meaning of "generational company”: Will this company still be around and thriving when he turns 18? Can I tell him when he becomes a legal adult that daddy and his partners and investors have owned shares in this company before he arrived into this crazy world?
It is a tough search, but the joy of searching is what gets me up every morning. To our investors, thank you for your trust in giving me the privilege to embark on this search, for you, your next generation, and mine.
Kevin S. Xu
February 2, 2025
(You can access the original letter in a view-only Google Doc link HERE.)
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.