We seek to develop and master investment strategies where the source of return is independent from the source of risk, banks or insurance companies previously dominated financing activity, and investments are privately placed. The first attribute is atypical, and we call it risk-return independence. In our view, risk-return independence is characteristic of an attractive alternative investment.
With traditional investments, the risk and the return have the same origin. For example, with a corporate bond, the issuing corporation is at the source of both the risk and return of the bond. This is not the case for some investments. An insurance company is the source of a catastrophe bond's return, but the risk of loss is driven by the occurrence of an independent event—for example, a Miami hurricane. As another example, the seller of a trade receivable, the trade creditor, is the source of return to an investor, but the risk of loss comes from the obligor of that receivable, the trade debtor. This risk-return independence can result in a risk premium greater than normally seen in the context of a traditional market investment.
Risk-return independence means that certain catastrophe bond investors are potentially able to receive a risk premium far greater than is normally associated with event risks like earthquakes in a traditional market setting. Similarly, certain trade credit investors are potentially able to receive a risk premium that is far greater than normally associated with the credit risk of the obligor. The elevated risk premium is derived from capital that is used to generate incremental business activity—for example, new insurance policies in a growing region.
Because, however, the risk to this capital is not linked to the incremental business activity (for example, the creditworthiness of an obligor is not directly related to that of a creditor), an investment manager can manage risk and return separately. This gives the manager greater freedom to construct an optimal risk-reward at the portfolio level.
Risk-return independence gives an investor the opportunity to "beat the risk curve" associated with traditional investments. Another benefit of the independence condition is that investors are able to potentially achieve a better return on their capital by focusing the investment on a narrow and well-understood aspect of businesses and industries. Risk-return independence can also potentially minimize poorly compensated general market or operational risks while still capitalizing on the excess returns associated with the products and services of the underlying business. If properly managed, this can result in an attractive alternative investment.