Following the post-COVID stimulus hangover in 2022, the bull market has continued to run. One of the key factors was the Federal Reserve’s decision to
Your Equity Exposure: Is Your Proxy a Sector Match or a Bad Imposter?
Published Date : November 5, 2019
The performance derived from individual stocks can be amongst the most rewarding portions of an investment portfolio. However, whereas a highly curated and diversified stock portfolio is more likely to provide a durable return, a smaller list of concentrated holdings may lead to a less appealing outcome. In this piece, we highlight the potential drawbacks of maintaining legacy stock positions whose best days may be behind them.
Have you ever found it frustrating when individual stocks you own don’t seem to replicate the return performance of the sector invested in? One would hope that if you own a stock in an oligopoly, that its performance would be highly correlated with its closest peer(s). The reality is single stock positions in the same peer group, facing the same market opportunity, often act very differently. When we come across positions that don’t track their underlying industry (or the intended investment theme), we label them as “imposters”. Unfortunately, investors often fall into the trap where they think “they are covered” with a position they expect will act as an adequate sector proxy, but instead the imposter causes an erosion of return in a portfolio.
The variation in individual stock returns so far in 2019 proves it can be difficult to expect that a sector proxy (or substitute) for one company over another will provide equal returns. In the bullet points below, we compare the total return of several large cap companies in the S&P to close peers on a year-to-date basis as of October 15th, 2019. For comparison purposes, the S&P 500 YTD is ~+ 20%.
- In Air Freight; United Parcel Service (UPS) + 22% vs. FedEx Corp (FDX) – 6%
- In Telcom Carriers; AT&T (T) + 41% vs. Verizon (VZ) + 12%
- In Materials (Paint); Sherwin Williams (SHW) + 43% vs. PPG Inc (PPG) + 17%
- In Apparel Manufacturing; V.F. Corp (VFC) + 38% vs. PVH Corp (PVH) – 5%
- In Technology Hardware; Apple Inc (AAPL) + 51% YTD vs. DELL +4%
- In Consumer Staples (Food); Mondelez (MDLZ) + 37% vs. Kraft Heinz (KHC) – 33%
The first example above depicts a scenario where, if an investor had been holding onto a legacy position in FedEx Corp (FDX) as a “proxy” for the airfreight and logistics industry, that they would have a negative return this year vs. United Parcel Service (UPS) which has had a return of over +20%.
Certainly, there have been years when the pairs listed above didn’t have such pronounced divergence in return. However, we are reminded that a company which might have been the sector leader historically, can lose their innovative spirit and become a laggard. To maintain leadership, a company needs to continually make intelligent decisions around key factors to drive respectable returns. A few of the key factors include the allocation of capital between research and development, capital expenditures, acquisitions and share buybacks while at the same time pruning their employee base to retain the best performers. We are also aware that the best companies mutate to fit the needs of the contemporary economy. Neither AT&T nor Apple offered the same products a dozen years ago and if they did, they wouldn’t have made it to the left side of the list above.
In summary, keeping an open mind to alternative potential holdings rather than hanging on to a legacy stock position for sentimental or capital gains tax minimization purposes is something that we advocate for at Sand Hill. Although there can be some reluctance to paying capital gains taxes, it can be therapeutic (and financially rewarding) to reallocate away from a legacy “imposter” position. In addition, the dividend stream from an underperforming equity position might seem appealing, but that yield rarely makes up for lost opportunity via investing elsewhere. We are long-term investors at Sand Hill, but rather than “set it and forget it”, we continually monitor our single stock positions and make adjustments if a particular company has a tough time, in our view, “keeping up with the Joneses”.
Please reference this chart and disclosures, which should be reviewed prior to or contemporaneously with this article.
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