Managing Risk
Defining Risk Management
Discrete movements in the prices of securities create potential gains and losses in markets. In choosing among investment options, investors should consider not only the direction in which an investment's price will move, but the extent to which it could move in either direction. Risk management is simply balancing the degree to which prices can move up or down with the investor's confidence in the direction of such movement.
Although volatility arises from movements in price, we believe the best risk-management practices do not view risk merely as a discrete quantitative measure. Rather, they weigh the probability of gain and loss based on a wide variety of factors ranging from financial leverage to personal integrity. This more-complex risk-management philosophy cannot be fully implemented by simply eyeing a few statistics. Risk is best managed by people who have years of experience dealing with highly volatile markets.
Our Experience in Handling Risk
The managing director of the Cimarron funds, Mark Jernigan, has spent a substantial part of his career handling market risk. At the Chicago Board of Trade he designed a proprietary arbitrage model to capitalize on trading opportunities. Mark also has spent 17 years assisting firms in carrying out trading strategies in the financial futures market. Risk management has been especially important in his experience in the financial futures market, where traders play a zero sum game: One investor's gain must equal another investor's loss.
In addition, other members of our investment committee have, through their careers in investment banking and investment consulting, assisted firms with portfolio management focusing on relative value strategies, and advised investment teams when to buy and sell securities to generate superior risk-adjusted returns. This experience is critical to achieving the Cimarron funds' goals.
Our Risk Management Goals
Our goal is to produce strong returns while maintaining a low level of volatility relative to equity markets. We accomplish this by combining investments that will allow us a reasonable opportunity to achieve equity-like returns over a market cycle. At the same time, we try to minimize the likelihood of a knock-out punch — a loss of such magnitude that it cannot be recovered in a reasonable period of time, if ever.
The principals of Cimarron have found some of the best risk/reward opportunities to exist in the hedge fund sector. In order to maintain a moderate risk profile in the alternative investments space, Cimarron's two funds are diversified across hedge fund managers and strategies. The portfolios are composed largely of funds that have superior historical return profiles but do not highly correlate. Underlying managers typically are focused on relative value discrepancies between securities or sectors and are not entirely dependent on market direction. Also, neither Cimarron fund employs leverage at the fund level, and the leverage maintained by underlying managers ranges from none to moderate. By combining excellent managers representing a variety of different, and often uncorrelated, strategies, we believe we can achieve our investment objectives and avoid undue volatility.
A concept of risk based on probabilities of gain or loss, rather than one that focuses too heavily on directional betting, is critical to effective risk management. Cimarron funds' principals have extensive experience in dealing with volatile markets which allows us to best implement a strategy to achieve our goal of superior risk-adjusted returns over a market cycle.