Protecting capital is our most critical mission and it's also our basic starting point. Allocation is the most important decision any investor makes when determining an acceptable level of risk. To protect our capital, we allocate among asset classes, limit our exposure to any one security or business, and hedge our portfolio. The extensive use of statistics helps us make better decision about allocation, exposure limits and hedging.
Owning securities which regularly pay distributions to their holders helps smooth investors' returns. We invest in high yielding financial instruments including funds and the equities of business development companies, partnerships, and real estate investment trusts. Regular dividend payments provide the bulk of investor returns and help reduce volatility.
Individual exposures to companies, sectors or asset classes can make sense if there's an identifiable end to the story. We take positions in securities of companies that we expect to revalue based on events - acquisitions, mergers, reorganizations, spinoffs, and other changes. Event driven investing increases the chances of generating above average returns, particularly in markets with stretched multiples and low yields.
We focus on yields in order to "get paid along the way" from interest and credit sensitive instruments like bonds or loans. We emphasize internal rates of return from expected events related to valuation sensitive instruments like common stocks and convertibles.
Statistical studies support our focus on obtaining regular payments. These matter, regardless of whether they come in the form of fixed income coupons, variable payments, production payments on limited partnership interests, or regularly declared share repurchases. Dividends, for example, accounted for 52% of the total return on S&P 500 stocks between 1988 and 2009.
Investors have to do more than collect dividends in order to earn above average returns. Historical data also suggests that strategies which focus on mergers, acquisitions, activist programs for change provide a path for creating events. We search for securities whose value is misunderstood in the market and whose price can be expected to change during a specific time frame due to accounting mishaps, delayed financial statement filings, asset dispositions or acquisitions, spinoffs, reorganizations, bankruptcies, or other corporate events. We analyze these events fundamentally and rank the expected returns quantitatively.
We combine fundamental analysis with statistics for positioning both long and short. We use statistically-based hedges to help extract the main components of return and seek to limit the exogenous threats to company valuations which all too frequently dent the securities markets as a whole.
We create our portfolio with the intention of limiting the underlying risk to either the timely cash payments we receive or the value we expect to realize from an event. This sometimes requires the use of different types of hedging instruments with different types of exposures to select equities, specific sectors, interest rates, credit spreads, or commodities.