In addition to the investment foundation that we use when allocating capital, we highlight our strong belief in protecting our capital base. This is essential for any investor since a too large drop in one’s portfolio will reduce compounded returns over time. The simple reason for this is that it takes time to work the capital back up to the starting point and during this whole time, no new returns are generated which could have been the case had the losses not been so dramatic.
As a result, the Mosaic Global Fund is taking means to-- as far as possible--keep our maximum loss target of 10-12% under any market condition. This feature is unique compared to the majority of funds being long only also requiring rising markets to make profits which are very exposed during times of market volatility when correlations between markets tend to increase.
The Mosaic Global Fund uses three levels of cushions to prevent larger loss of capital. The three cushions are (in no particular order): Diversification, long volatility investments and option strategies (covered call).
Diversification - The benefits of diversification is explained in the Cardea Investment Foundation document. As is widely accepted in the investment industry, the more you can diversify your portfolio the higher your risk adjusted return will be. This means in plain English that when you add another asset with different risk and return characteristics, the overall risk reduces while your risk adjusted return increases.
The Mosaic Global Fund does this through allocation of capital across a large number of asset classes including the traditional stocks, bonds and cash; further, includes commodities, private equity, hedge funds and managed futures. Additionally, could be said that the traditional stock and bond allocation will also include emerging markets as well as a dividend on value and grow stocks as well as large and small cap due to their distinctly different return characteristics.
Long Volatility Investments - Essentially investments that benefit when there is an increase in volatility or movement in the market place, the most common form of long-volatility investment is managed futures. Managed futures programs are more described in a separate document on the Cardea webpage; In short, they have a more than 30-year history of producing returns during difficult times in the stock markets. This is due to its trend-following nature and the fact that the investment strategy benefits from both markets trending higher and lower. Besides protecting the portfolio capital in adverse times in the markets, they produce very good stand-alone returns during more normal market conditions. The Mosaic Global Fund has a substantial allocation to managed futures which we feel is an important part in our risk management toolbox.
Hedging Strategies - The Mosaic Global Fund has the opportunity to sell options against, for example, its equity holdings. Simplified, this means that we can offer an investor to buy our holding at a higher price through the sale of an option. This way of increasing returns through a yield- producing hedging strategy is well documented and used by a lot of hedge funds to dampen volatility or lock in profits.
The strategy works well in markets which are moving slightly higher, moving sideways or have a negative bias. We do know markets tend to trend only around 30% of the time; for that reason, selling options will add positively to our performance during most times. There will most certainly be markets where we might limit our upside potential; although, through the results of our internal research, we are confident that for our style of investing (where capital preservation is of utmost importance), using these types of option strategies is a very good complement to our overall strategy.