Volume 48 July 2019

4 ROE REPORTER | DKAM Risk The term “volatility” gets thrown around a lot. There seems to be a common perception that equity hedge funds that aim to beat the market are inherently risky. There have been a few high-flying funds of the past, many of which relied on leverage, which may be the cause of this reputation. We would like to address this topic, where we think we lie on the risk spectrum, and our general approach to the matter. When most people refer to a fund’s volatility, they are referencing standard deviations of returns or Beta (i.e. how much a fund’s or stock’s returns vary from day to day or vary compared to an index). We appreciate that there are other metrics that aim to capture this balance between risk and return, or adjust for not treating upside volatility the same as downside volatility, but we still often encounter improper use of the calculation in general. Most standard risk metrics penalize upside performance the same as downside performance even though good investments are supposed to disperse higher from their starting points and higher from their relative indexes. Yes, our fund has a higher standard deviation since inception compared to the index 2 , but on average the Capital Ideas Fund has been positive on a monthly basis 71% of the time with a 1.45% average return per month. The S&P/TSX Total Return Index 2 on the other hand has been positive on a monthly basis 63% of the time with a 0.57% average return per month. The point being that knowing the underlying quality of the assets driving the returns is more important than day to day changes in price. The real volatility of the fund is a function of the risk metrics of the underlying investments in the fund, especially for us since we typically don’t use leverage. We are stock pickers who aim to own the highest quality businesses in the market. For the most part, we own companies with solid balance sheets, high rates of recurring revenue, and a sustainable competitive advantage that are trading on fair valuations. We call these companies compounders and they continually grow the value of the underlying businesses independent of what the stock market does from day to day. A final point on risk is the issue of investment time horizon. As an investor, your time horizon is critically important to the topic of risk. Any investment has a high risk of potential loss if you’re looking to buy and sell it in a day, a week, or even a month. Many random events can come into play with any type of asset. For our fund, we approach this problem the same way knowing that tomorrow, next week, or next month, the stocks we own could be up or down. We aren’t in control of what the market will quote us each day for the businesses we own. But over the long term, owning companies that are compounding the value of