Achieving consistent outperformance in investing is akin to finding a mythical silver bullet – elusive. At Peregrine Capital, we aim to achieve superior risk-adjusted performance by constructing a portfolio of uncorrelated return streams.

For the past 26 years, diversification has been a cornerstone of our investment process.

Fundamentally, diversification means strategically allocating funds across select uncorrelated assets to mitigate the impact of any single investment’s poor performance on the overall fund.

Many businesses interpret diversification too narrowly, focusing solely on spreading exposure across different asset classes. This approach can be misleading, as it assumes that different asset classes will always behave independently of one another.

The reality, as starkly demonstrated in the Covid era, is that asset class correlation can converge to 1.

This means that during certain market-moving events, asset classes can move in tandem, rendering traditional diversification ineffective.

To truly diversify, we seek out investments that are driven by distinct return drivers, not just different asset categories.

For instance, our investment in Fortress Real Estate is driven by factors fundamentally different from our exposure to global tech and AI hyperscalers, which are influenced by technological advancements and digital transformation trends.

By selecting assets with distinct return drivers, we reduce the risk of correlated downturns, enhancing the potential for generating stable, long-term growth for our investors.

Consider a sports team, like a soccer team …

A successful soccer team comprises players with different skills and roles: defenders, midfielders, forwards, and goalkeepers.

Each player contributes uniquely to the team’s success.

Similarly, our objective is to construct a portfolio with diverse return buckets serving different purposes – some for growth, others for stability or risk management – working together to achieve optimal returns at the lowest possible risk.

Defenders = risk management

In soccer, defenders play a crucial role in protecting the goal.

They are analogous to the risk management strategies we use at Peregrine Capital.

Just as defenders prevent the opposing team from scoring, we employ specific investment positions to maintain portfolio balance and protect our investors from experiencing significant losses. This might include investing in fixed-income opportunities like USD bonds.

Midfielders = consistent compounders

Midfielders are versatile players who support both defence and attack. They provide stability during the flow of a game, much like our positions in select established businesses with strong cash flows and attractive earnings, especially during changing market conditions.

Forwards = growth and alpha generators

Forwards are tasked with scoring goals and represent a hedge fund’s growth and alpha generation strategies.

These players are akin to high-conviction investments in sectors or assets with strong growth potential. Occasionally, we pursue alpha opportunities through strategic investments in special situations. These exposures can significantly enhance investor returns, much like a highly skilled player driving a team to victory.

The Peregrine Capital funds are benchmark-agnostic, meaning that we focus on investments with the most attractive return prospects. We concentrate to grow, and diversify to protect, resulting in returns uncorrelated with the overall market and most other unit trusts that track a benchmark in South Africa.

Goalkeeper = short book

Just as a goalkeeper serves as the last line of defence, preventing the ball from entering the net, specialised tools like the short book in the world of hedge funds act as protective barriers for investors, shielding them from declining asset prices.

During the Covid-19 pandemic, we utilised these tools to mitigate losses, like a goalkeeper thwarting opposition goals.

This strategy significantly contributed to the impressive net returns of our two key funds – the Peregrine Capital High Growth H4 QI Hedge Fund and the Peregrine Capital Pure Hedge H4 QI Hedge Fund – of 17% and 12% respectively in 2020 .*

Ray Dalio emphasises the significance of diversification in his book Principles: Life and Work. He writes: “The key to investing well is to diversify well.” You must be both defensive and aggressive at the same time. If you are not aggressive, you will not make money; if you are not defensive, you will not keep the money. A well-balanced portfolio is crucial for long-term investors seeking consistent growth.

Just as each player in a sports team has a specific role, each investment we allocate funds to has a specific purpose. All are aimed at maximising our investors’ returns while minimising the risk that they experience across all market environments.

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