2018 June CAD

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-1.07% MTD
11.17% YTD

Dear Partners,

For the month of June the Caravel Cad Fund Net Asset Value lost 1.07%. For Caravel Capital the past two months have been an exhausting seminar in the Alchemy of Securities Markets. What we have learned is now incorporated into Caravel Capital’s investment management modus operandi. We would like to share this with our partners.

Most if not all are familiar with the law of supply and demand as it relates to price discovery. In securities markets this law translates: The rate of return on an investment is determined by the amount of capital willing and able to invest relative to the size of the opportunity. Determining the size of the opportunity is a fundamental exercise. When two companies announce their intension to merge, the capital that is willing and able to invest in the company being acquired transitions from fundamental holders to arbitrageurs. The amount of arbitrage capital willing and able to invest is largely determined by a few factors:

  • The fundamentals of the merger
  • The risk adjusted rate of return the opportunity offers relative to other investments
  • The ability to execute the strategy.

If one of these factors changes substantially during the life of the investment the capital willing to invest may transition back to fundamental investors from the arbitrageurs. When this occurs, the fundamental market forces of supply and demand will set the price of the securities.

In late April Caravel Capital seized a window of opportunity in the securitization market that allowed it to be one of the few firms with the ability to invest in a large fundamentally sound merger arbitrage opportunity. When the number of price setters is limited, merger arbitrage rates of return are often very high. Our combined experience told us that arbitrage capital would enter the market and compress returns as the ability to invest in the strategy increased. What occurred next perplexed us. The ability to invest inexplicably dried up in mid June. We were literally one of very few who could invest in the strategy...it was a 6 billion dollar merger. Literally 350 million shares of the acquiring company vanished from the securitization market. The 3 billion dollars of supply from sellers of the target company’s shares (supply) overwhelmed the few hundred million dollars of arbitrageur’s capital (demand). The price discovery for the target company’s shares transitioned back to fundamental holders. We had acquired an investment that had an incredible rate of return with little to no risk in it. However our failure to quantify the ability to invest the capital needed to transition price discovery from fundamental holders to arbitrageurs exposed the Caravel Capital Fund to systematic and non- systematic market forces for 50 days. This critical oversight caused the Caravel Funds to generate 2 negative return months.

Although May and June would have been positive, they were not going to be extraordinary as we had a few separate strategies that worked against us. Rather than discuss those, we felt the partners should receive the above explanation and the knowledge that our models now incorporate a complex filter that identifies the arbitrage capital required to effectively transition price discovery from a fundamental investor to the arbitrageur. We hope we did not turn this into a seminar in finance, but rather an exercise in transparency.

We thank you for your confidence and capital.

Jeff & Glen

Monthly Performance (net of all fees)

JanFebMarAprMayJunJulAugSepOctNovDec YTD

Risk vs. Return Comparisons Across Indexes

Month Return YTD Return Volatility Sharpe Sortino Beta Best Month Worst Month Annualized
S&P 5000.62%2.65%7.37%1.693.80.255.72%-3.69%15.08%

Growth of $1000 since inception

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