By Gary Brooks, CFP®
This post is more a fun little exercise in curiosity than any investment recommendation.
Many of our clients – and prospective clients we speak with – have a local flavor in their investment accounts. In the Puget Sound area there are several companies that have risen to global prominence and their stocks are frequently held.
With this partly in mind, I was curious what a portfolio of Washington companies would look like. If you chose to invest only in local companies, could you build a reasonably diversified portfolio that had a compelling risk/return profile?
There are 76 publicly traded companies that are headquartered in Washington. The full list is here. It was generated from a searchable database on Nasdaq.com and cleaned up a bit to eliminate companies no longer traded. One quick reminder that Boeing is no longer a Washington-headquartered company so it does not appear in this analysis even though it is a major Washington employer.
If you evaluate the list in terms of market capitalization (size of the company in terms of market value), Microsoft dominates. The Microsoft weight would be 40.3% of the Washington portfolio. Amazon.com would equal 28.6% of the portfolio. This concentration wouldn’t be compelling from the perspective of building a diversified portfolio. You would have an awful lot of risk in just two companies. As Microsoft and Amazon went, so would go the entire portfolio regardless of the performance of the others. The bottom 47 companies by size represent only 1% of the Washington companies.
Since market cap weighting would not be a compelling investment, I considered equal weighting. What if you bought the same dollar amount of each company? You could technically do this with the entire list but giving the many very small companies the same weight as Microsoft and Amazon would distort the weight of the portfolio to more speculative investments. So I settled on a portfolio of the largest 15 stocks, meaning each would have a 6.66% weight in the portfolio. This group of 15 represents over 95% of the market value of all Washington stocks.
|Expeditors Intl||Plum Creek Timber||Tableau Software||F5 Networks||Seattle Genetics|
Using Vanguard’s Portfolio Analytics tool it’s possible to track this portfolio back to May 1, 2013, the oldest commonly traded date for all 15 stocks.
The results are interesting. With this equal-weight approach, the portfolio of 15 Washington stocks strongly outperformed the S&P 500. A hypothetical $100,000 investment grew to $159,394 in the Washington portfolio and $131,508 in the S&P 500. (This hypothetical portfolio doesn’t accommodate for transactions costs or other fees and taxes.)
The Washington portfolio would lack exposure to notable sectors that are included in the S&P 500. Among the 15 Washington stocks there are no energy, utilities, financials or real estate. You can see the sector comparisons here.
The Washington portfolio would be overweight cyclical companies meaning they are more susceptible to changes in business cycles. Amazon, Starbucks, Nordstrom, Expedia all are considered cyclical.
The 15-stock Washington portfolio would also be heavily tilted to growth-oriented companies. This means that companies are more focused on growing their earnings by reinvesting their profits in more research and development. This is generally the case with emerging, younger companies that have significant growth prospects. Whereas value-oriented companies are more mature, have less ability to grow, often pay dividends back to investors, and may be trading at more attractive prices. Investors are usually willing to pay more for each dollar of earnings for a growth company than they are for a value company.
While the cyclical and growth overweights introduce more risk in the Washington portfolio compared to the S&P 500, another measure of risk is surprisingly tame.
Correlation measures the extent to which two investments move in similar patterns. If you prefer diversification and risk management in your portfolio, you don’t want all your investments to be highly correlated. This may not cause concern when all are moving upward but when all are moving together in declining markets and there are not pieces of your portfolio providing some cushion in the more challenging times, high correlation can be problematic.
The Washington portfolio has low to moderate correlation. The trading patterns of the 15 stocks are not significantly linked. This means that even just 15 stocks can produce a fair amount of diversification.
This approach has some characteristics that are interesting but the sample size of this example is limited and there is no reason to think that over the next few years this portfolio wouldn’t underperform the S&P 500 by as much as it has outperformed over the past couple years.
While this information may satisfy curiosity (at least my own), it’s not exactly an endorsement to apply this approach as a core piece of your own portfolio.
~ Brooks, Hughes & Jones Wealth Advisors — Gig Harbor, Washington — www.BHJadvisors.com