Mastering the Art of Diversification – Moneyweb

Consistently outperforming in the investment realm is akin to searching for a mythical silver bullet – it remains elusive. At Peregrine Capital, our goal is to attain superior risk-adjusted performance by crafting a portfolio comprised of uncorrelated return streams.

Diversification has been a foundational element of our investment strategy for the past 26 years.

At its core, diversification involves the strategic allocation of capital across carefully chosen uncorrelated assets to minimize the impact of any one investment’s underperformance on the overall fund.

Many firms view diversification too narrowly, concentrating mainly on distributing risk across various asset classes. This mindset can be misleading, as it presupposes that all asset classes will consistently act independently.

The harsh reality, as starkly illustrated during the Covid period, is that asset class correlations can converge to 1.

This indicates that during market-moving events, asset classes may move together, rendering traditional diversification ineffective.

To genuinely diversify, we seek investments driven by distinct return mechanisms, rather than merely different asset classes.

For instance, our investment in Fortress Real Estate is influenced by fundamentally different factors than our commitments to global tech and AI giants, which are shaped by technological advancements and the digital transformation landscape.

By choosing assets with unique return drivers, we can lessen the risk of correlated downturns, thereby enhancing the likelihood of delivering stable, long-term growth for our investors.

Imagine a sports team, such as a soccer team …

A winning soccer team is made up of players who possess varying skills and roles: defenders, midfielders, forwards, and goalkeepers.

Each player’s unique contribution is vital to the team’s overall success.

In the same way, our aim is to build a portfolio with diverse return buckets, each serving specific roles – some for growth, others for stability or risk management – collectively striving to achieve optimal returns while minimizing risk.

Defenders = risk management

In soccer, defenders are crucial in safeguarding the goal.

They are akin to the risk management strategies we implement at Peregrine Capital.

Just as defenders block the opposing team from scoring, we utilize targeted investment positions to maintain portfolio equilibrium and guard our investors against significant losses. This may involve investing in fixed-income assets such as USD bonds.

Midfielders = reliable compounding

Midfielders are multifunctional players who bolster both defense and attack. They provide stability throughout the game, similar to our investments in established firms with robust cash flows and appealing earnings, particularly amidst fluctuating market conditions.

Forwards = growth and alpha drivers

Forwards are charged with scoring and embody the growth and alpha generation strategies of a hedge fund.

These players resemble high-conviction investments in sectors or assets with substantial growth prospects. Occasionally, we target alpha opportunities through strategic investments in unique situations. Such investments can significantly boost returns for investors, much like a talented player leading a team to victory.

The Peregrine Capital funds operate independently of benchmarks, allowing us to hone in on investments with the most promising return prospects. We focus on growth while diversifying for protection, yielding returns that are uncorrelated with overall market movements and most other unit trusts that adhere to a benchmark in South Africa.

Goalkeeper = short book

Just as a goalkeeper acts as the final line of defense to stop the ball from entering the net, specialized tools like the short book in hedge funds serve as protective measures for investors, shielding them from falling asset prices.

During the Covid-19 pandemic, we employed these tools to minimize losses, similar to a goalkeeper blocking the opposing team’s shots.

This approach significantly contributed to the remarkable net returns of our two flagship funds – the Peregrine Capital High Growth H4 QI Hedge Fund and the Peregrine Capital Pure Hedge H4 QI Hedge Fund, achieving returns of 17% and 12% respectively in 2020.*

Ray Dalio underscores the importance of diversification in his book, Principles: Life and Work. He states: “The key to investing well is to diversify well.” You must adopt a dual approach: being both defensive and aggressive simultaneously. Without aggression, profits dwindle; without defense, capital is at risk. A well-balanced portfolio is essential for long-term investors pursuing consistent growth.

Just as every player in a sports team has a defined role, every investment to which we allocate funds has a specific objective. All are designed to maximize returns for our investors while minimizing risk across varying market scenarios.

* Disclaimer:

Peregrine Capital High Growth H4 QI Hedge Fund and Peregrine Capital Pure Hedge H4 QI Hedge Fund are part of a collective investment scheme in hedge funds, managed by H4 Collective Investments (RF) (Pty) Ltd, a registered manager under the Collective Investment Schemes Control Act, 2002. Collective investment schemes are intended for medium- to long-term investment horizons. Previous performance is not necessarily indicative of future results. The value of participatory interests (units) may fluctuate.

Performance figures are shown net of all fees and expenses and reflect actual returns to investors. Performance is calculated using net asset value (NAV) to NAV pricing, with income reinvested. Individual returns may vary based on the investment date and applicable fees. The performance history is available in the portfolios’ minimum disclosure documents, which can be requested from H4 or Peregrine Capital.

Fund	Highest annual return	Lowest annual return	Latest 1 year	Latest 3 Years	Latest 5 years	Latest 15 years	Since Inception
High Growth Fund	53.01% (2004)	-11.98% (2008)	19.65%	17.32%	17.13%	23.02%	23.14%
Pure Hedge Fund	67.90% (1999)	1.61% (2008)	13.79%	14.79%	12.20%	12.40%	18.82%

As of 28 February 2025

Returns mentioned in this article are for the 2020 calendar year and are based on audited results. A detailed schedule of fees, charges, and the Minimum Disclosure Documents (MDDs) can be provided upon request.

Full disclaimer.

Kavita Patel is an investment specialist at Peregrine Capital.

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