Why AAMA’s Sector Allocations Have Remained Stable Through So Much Volatility

Providing value as an investment manager isn’t always about movement. Sometimes it’s about using data to filter out noise and volatility, maintaining a clear view of opportunity and risk in the market.

It might surprise some readers to know that Advanced Asset Management Advisors (AAMA) hasn’t made a substantial change to our sector allocations since before the COVID-19 pandemic.

But there’s good reason for this lack of movement, which we discuss below (or, if you’d rather listen to the original discussion between AAMA President, Bob Baker, and CIO, Phil Voelker, click here).

As a fundamental asset manager, our convictions are rooted in black and white statistics – things like price, valuation, and earnings.  To put it simply, we seek to take advantage of undervalued sectors that may be positioned for growth while limiting exposure to those with higher perceived risk. It’s not a black box model, but we are guided by the fundamentals of market pricing and sector valuation. And when the fundamentals begin to change, we consider portfolio allocation changes. But on the flip side, if the fundamentals remain stable, or if the fundamentals move uniformly across sectors, our targets may remain stable for an extended period of time.

We currently find ourselves in one of those times, where AAMA’s sector allocation targets have remained relatively stable since December of 2019, just before the COVID-19 pandemic – yes, despite the extreme volatility seen over the past three years.

So let’s jump back to 2019, when we last adjusted our sector allocation targets, and discuss how the markets have moved and how our fundamental process has worked throughout.

In December of 2019 the market was overvalued (fairly significantly). Most sectors were above their median historical valuation metric. The sectors that weren’t overvalued had questionable earnings outlooks. Approaching 2020, we saw a lot of risk in the market. We didn’t predict the COVID-19 pandemic, of course, but the market could be perceived as risky all the same. Seeing this risk, which had built over the year, AAMA’s investment team began to structure our portfolios to not include any major sector overweight. Instead, we sought to upgrade the quality of our portfolios.

Within each sector, we screen a database of roughly 700 companies that are 7 billion in market cap or higher. We use quality screens to filter and evaluate opportunities within each sector. Let’s look at how that plays out in our portfolios.

Using debt to EBITDA as an example, our core growth fund portfolio is at 2.1 times versus the universe at 3.8 times.  Looking at Price to Sales, our portfolio is roughly half of the universe. The forward P/E ratio of our growth portfolio is at 85% of the universe. The trailing P/E ratio is about 60% of the universe. And the return on equity is slightly higher than the universe.*

What does this all mean? It means we’ve established and maintained quality in large cap positioning. This is a practical example of our fundamentally-rooted response to an overvalued market, where there’s limited opportunity to take advantage of a cheap sector with attractive earnings. This is the market environment we’ve witnessed since December of 2019.

Some readers might ask, “what happened in the fall of 2022 when the market was down 25% at its lows?”

In that case, many of the sectors (and market in general) pulled back to just-above-median valuations. But they did so uniformly. This uniform change did not create an opportunity to take advantage of sector undervaluation. Rather, it only emphasized the fact that a diversified sector portfolio, with good quality screens, was appropriate for the environment.

Fast forward to 2023, and we’re right back to where we were with widespread market overvaluation.

Since 2019, AAMA has identified one sector to be consistently more attractive than the others, and that’s Healthcare – which we’ve cited consistently in our market commentaries. Healthcare has been less consistently overvalued, compared to other sectors, and has maintained a double-digit earnings growth forecast. Because of this, Healthcare has been a consistent overweight for the AAMA equity portfolios.

On the other hand, Financials has been a consistent underweight. While the Financial Sector has looked undervalued at times, the prospect for rising interest rates and the uncertainty of earnings stability and quality has led us to limit exposure to the sector – due to higher perceived risk.

We hope this provides some perspective into AAMA’s investment philosophy. We remain committed to the time-tested fundamentals of market pricing and sector valuation. As such, we constantly evaluate the market, its sectors, and the investment opportunities within each sector. And we’ll continue to do so in the future.

Want to learn more about our sector valuation process? Don’t hesitate to reach out to use. Click here to contact us. We’d love to speak with you.