Monthly Letter August 2013

Proac ve. Ac ve. Reac ve. What would you rather be? Most of us ins nc vely would say proac ve. Who wouldn’t want to be one step ahead? Be ahead in the thought process of future events. Be a thought leader. Be the one who has the perfect posi ons for the unthinkable events. We at Madrague certainly have our moments when we think “if only”… not very produc ve thinking as it certainly does not improve investment performance. The ip side of being posi oned for the unlikely events though is that you are not posi oned for the most likely events. This is easily forgo en when we read about the homeruns that some in- vestors have made during periods of extreme stress in the system. It is costly to be on the wrong side of the probability distribu on for an extended period. We nd that it is nigh on impossible to try and market me those events. In a recent discussion, one of our close friends in the market laid out the web of con icts and con ic ng interests in the Middle East that could blow up, triggered by how the crisis in Syria was handled. The situa on was likened to the run up to World War I and the shots in Sarajevo. It is always worrying when a smart and knowl- edgeable person you trust lays out such a scenario.

The key though was his conclusion: “But this is something you can’t trade on”. In this statement lies a lot of wisdom, we certainly believe. With all the awless logic in his reasoning he recognized that it was s ll an outlier. This is very much how we look at managing risk in our por olio as well. We have downside op on protec on if any of these unlikely events come true. There are a couple of occasions every year when tail risks of varying types come to the surface. We are not neglec ng them and we do of course spend a lot of me trying to gauge the risks and the likelihood of these di erent events. Very rarely though do we change our overall por olio because of them. We might buy more downside protec on and we might on the margin change our gross and net exposure, but from there to fully rework the en re por olio is a long way. If you change your posi ons to these events every me you will have spent a large part of your hard earned returns chas- ing unlikely returns. In short, we are proac ve in looking for new investments, ac ve when it comes to managing our por olio and reac ve to tail risk events.

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