During any market correction — we’re lumping corrections and bear markets into one category for this article — a common question is how are you managing risk in the AMM Dividend Growth Strategy?
Risk management is something that happens before a correction not during. Bull or bear market, we manage the AMM Dividend Growth Strategy the same way.
Don’t Play the Guessing Game
We don’t want to be in the short-term game of trying to guess which way the market will move. This game is ripe for short-term emotional decisions that lead to over-trading and poor performance. We want to be in the business of investing in high-quality companies within a secular growth trend. Then we want to give them time to compound.
It is enticing to get into the market timing game. One correct market call can make your career. But no one can predict the future not even “psychics”. The future is probabilities, possibilities, and most likely outcomes. You can position yourself to take advantage of these potential outcomes; but if anyone says something is a certainty, we recommend walking away from them very quickly.
Focus on Quality
We seek to build portfolios that are filled with companies that generate high returns on invested capital, have one or more competitive advantages that sustain their high ROIC, and are within a secular growth trend. While these companies are not immune to a market correction, they often exhibit lower volatility than the broader stock market.
The companies in the Dividend Growth strategy also generate significant amounts of free cash flow. They can self-fund their growth and typically have capital left over to buy back shares and/or increase their dividend during market corrections.
Portfolio & Trading Rules
We have position size rules which help remove the emotions from trading. We have rules to add to a position if it gets too small in the portfolio or to trim a position if it gets too large. We follow these rules regardless of the market direction.
We also maintain a shopping list of high-quality companies we would like to own at the right price. The right price may come at any time, but market corrections provide the most opportunities. We don’t want to sell a position because it’s down in price but we’re always looking to upgrade the quality of the portfolio. This may necessitate liquidating an existing position for a better opportunity.
More Tortoise, Less Hare
Finally, we move slowly. 75% of our positions and watchlist names are currently below our estimate of fair value. We’re not buying every name right now. We’ll add to one or two names one week and then another one or two other names next week and so on. When there is a severe market dislocation like 2020’s Covid market panic, we’ll look to pick up the pace. Moving slow helps us sometimes and hurts us other times, but it tends to be a wash.
Risk management starts with the type of companies we invest in and the price we pay. Once we have invested in a position we focus on our portfolio and trading rules to manage risk. Market corrections are painful and bear markets even more. That’s why we rely on our systems and processes. We don’t want our emotions to get the better of us.
