11/12/21
By Mark Sauer
Our job as investment managers is to make our clients money while protecting principal. We have found that traditional risk management approaches create more opportunity cost than anything else. These traditional risk management methodologies do largely diversify out risk but diversify out opportunities as well. We aim to solve this issue – not through rigorous diversification alone but through a proprietary use of our technical indicators which illuminate present market sentiment so we can best discern when to add to a position, when to take profit, and when to exit. For this reason, we like to say that we take an offensive approach to risk management – being proactive-asset-managers, rather than passive-asset-allocators.
The traditional approach
Traditional-asset-allocators employ a Modern Portfolio Theory (MPT) approach which is effective for ultra passive investing environments whereby the managers don’t necessarily have a breadth of knowledge around price movement in the markets. Rather, they find value in riding the waves of the market’s ups and downs and using a “buy everything” approach to lessen the blow of any particular investment, sector, index or market-cap entering a bear market or contraction period (loss in value). This is what you’ll get when you go to most large banks, retirement planners, wealth managers, etc..
Our approach
The number one rule we have found when it comes to investing is: Perception of value drives value. Value, in and of itself, does not.
Hear us out. An investor who purely looks at the actions of a company and their fundamentals is a speculator. They are speculating that those actions will impact the fundamentals of an investment which will result in positive (or negative) change in the prices of said investment. However, the change in price is ALWAYS a result of the total market’s perception of said value of those changes.
A perfect example of this is Ford Vs Tesla. Ford’s annual revenue is $127 billion with a market cap of $78 billion. Whereas, Tesla has only $31 billion in revenue but a total market cap of over $1 trillion. The price is based on future market innovation and expectation – not current value creation, but perceived future value.
As proactive-asset-managers, we look at the chart – of a given stock, sector, index, market, etc. – which gives us a present moment evaluation of the market’s perception of value. Rather than speculating where value should be, we listen to what the market itself has to say. Again, perception of value drives value. Value, in and of itself, does not.
Diversification is, of course, a pillar of any well-balanced strategy when it comes to investing. Despite our disdain for traditional asset-allocators leveraging ONLY this methodology, we absolutely do find it useful within our own strategy. We simply feel it’s best used alongside the many other tools in our quiver.
Three pillars to AOA’s offensive risk management
- Rebalancing
As mentioned, we employ a diversified strategy. Typical positions range from 3%-10% of a portfolio’s value. Within this diversified approach we seek to ride the momentum of price movement during the expansion period (growth) of a given investment.
This means, instead of reallocating when a threshold is met, we wait until the trend’s momentum deteriorates.
Asset-allocators typically have a threshold for portfolio rebalancing when an investment grows to a certain level – for example, when growth of an investment goes from 3% to 4.5% a threshold would trigger a sale to reduce the investment back down to the original 3% position of the total portfolio. We do not do this. We follow the chart and price movement – once the trend deteriorates we then make the conscious decision to either take our profit – reducing the position back to its original size – or consider exiting the investment altogether.
- Market Filter
Similar to how we rebalance, we look at the broad market – and likewise, sectors/industries/indices we are participating in – to aid us in determining how much of our total portfolio should be invested at any given time. Utilizing cash and more defensive investments to park our capital during deteriorating market conditions. As above, so below. If the broad market is systemically deteriorating, most often, so will our individual investment holdings. We seek to look at the macro and micro environments to best manage risk.
Once market conditions change, illuminating a more positive market sentiment, we re-invest and/or increase allocations to participate again.
- Thematic approach
Thematic investing can be purpose driven – seeking socially aligned value investing – or perception of value driven – identifying industries or sectors we believe will grow as a whole. Our thematic approach seeks to find market themes which engender exponential growth for our investors. Our management strategy is designed to adapt to markets as business cycles evolve allowing us to have dynamic market exposure as volume within different market themes shift.
Growth within these themes come from advancement in technology, capital markets (inflation), change in investor preference and innovative industry disruptors (Tesla, Zoom, Paypal, Amazon, Apple).
Rather than merely participating in all themes to be “diversified” we seek to identify growing/expanding themes where we can allocate more capital to participate in their exponential growth.
The result: our returns
This offensive approach to risk management has resulted in a 3-year-annualized return of 21.89% (as of 10/31/21).
We look forward to helping you invest in the companies of tomorrow through mindful risk management.
