By Axel Steinmetz
As an undergraduate investing club, limiting the range of investment opportunities sounds strange. Why not be open to all investments to allow students to pursue what they want to learn about within the finance world? If you put it that way, I’ll admit it doesn’t sound great. So why do it? The simple answer is because it makes sense to us, for a whole host of reasons. In this post, I will argue that restricting the types of investments is not a limitation, but actually an act which give us clarity, focus, and even freedom in the complicated world of investing.
First, I’ll explain why it gives us clarity. Michigan has 76 publicly traded companies alone. The whole upper-midwest region has 924 public companies comprised of Michigan, Ohio, Indiana, Illinois, South Dakota, North Dakota, Wisconsin, Minnesota, Iowa, Kentucky and Nebraska, and that number is changing every year. Of course, some of those are too small for us to seriously consider, but even excluding those ones we end up with a list still far too large for any undergraduate club to realistically research all of them. By limiting our company search from the start, we effectively become more focused which makes the task of idea generation less daunting.
Next, we chose to invest in Michigan because of our own location.
The University of Michigan is a public school, so roughly half of the students are actually from the state of Michigan. Within VVI, less than 50% of members are from Michigan, but that doesn’t concern me because we’ve only been around a year or so and I’m sure those numbers will change in time. Regardless, with many members from Michigan, it makes sense for us to mostly focus on Michigan Companies.
If we are researching a company like Dow Chemical, for instance, getting the input of a member from Midland may be hugely beneficial. I’m not talking about any inside information stuff, for I doubt any of my friends from Midland whose parents work at Dow could even give me any inside information if they tried. Instead, learning things like if employees are happy at work, why employees may be leaving, learning first hand what employees think of management, and so on can help us make a more informed investment decision. On top of that, this approach can save us time. Instead of going on LinkedIn to try to find professionals who want to talk to us themselves, we can leverage the connections our members have from the start. Although it is also worth noting that we go on LinkedIn anyway to try to find people to talk to regardless of whatever connections we may have. Doing this kind of work is a fundamental value investing strategy by the way, nicknamed the “scuttlebutt” method by Philip Fisher.
Many funds make use of expert networks, which cost something like $100,000 a year. For anyone who doesn’t know, these are companies that help link investors to employees where information can be exchanged freely as long as nothing pertaining to inside information is revealed. While these services can be of enormous value to investors, VVI doesn’t have the luxury of hiring a service which makes connections for us. However, by focusing on Michigan companies, we have a higher chance of knowing someone at the company we are interested in. Thus, we can get some of the benefits of using an expert network without actually using their service. In conclusion, it’s easier to use the connections we already have, and we have the most connections in Michigan because of our location.
(Note: Someone told me this sounds like we are trying to get insider information, so I wrote a blog post titled “Thoughts on Expert Network Usage” about this topic where I argue against that sentiment.)
The next reason for why we invest in Michigan is because it helps get members engaged. Investing in companies that are familiar to students is a great and simple way to boost engagement, where many members have some type of personal connection to the company. The downside is of course that members may be personally interested in the company which clouds judgement, but the group work and discussions with the whole club before investing helps mitigate that risk.
However, there’s a simple argument against the engagement argument, and one that I don’t have a good answer to. Just about everyone is more familiar with Google than they are with Credit Acceptance. Google, of course, is based in Southern California, and is thus off limits to VVI. Therefore, does it really make sense to say that we invest in Michigan because of engagement?
I’ll admit it would be nice to own Google, but at what cost? Opening up our investment pool to all U.S. companies and loosing our image as a Midwest focus club? I believe the focus and clarity we gain from only looking at the Midwest outweighs the cost of not investing in companies outside our designated area. Remember that there is no guarantee that Google will outperform the market a year from now or 5 years from now, same as any company in our own portfolio. The Midwest index performs just as well as East Coast and West Coast indexes, thus I don’t believe there is any loss in trying to limit our focus to Midwestern companies. Through careful analysts we can find plenty of quality Midwestern companies that for one reason or another we think are undervalued to hold on to for the long-term.
And, for the same reason that a connection to a Michigan company may cloud judgement, club analysts may not be looking at a company they know well that’s not in Michigan for the right reasons. A company like Tesla may be a good example of this. Students love Tesla, but that doesn’t make it a good long-term investment.
Additionally, not everyone is going to have a connection to the companies that they look at, but they don’t have to. Instead, VVI gives students the opportunity to look into industries they are interested in, even if the exact company they are interested in is off limits. Interested in banking? Chemistry? Fintech? Cars? Insurance? Energy? Berkshire Hathaway B shares alone (which we can actually afford) have over 20 industries packed into one stock easily. The Upper Midwest has a highly diverse landscape for investors. Whatever analysts are interested in, they can find it in here.
I digress, the state of Michigan on its own was a little too narrow and not quite diverse enough for us. Although I personally like industrials, expanding to the Upper Midwest regions allows for a little more diversity without compromising out image. I’m also an optimist when it comes to where we’re investing. There are countless articles hailing the Midwest to be the next Silicon valley because of its cheaper livings and rent costs, and I think tech companies in the Midwest will grow greatly because of all the “untapped potential” that all these Detroit blogs are talking about.
Good marketing potential is the next big reason we chose to adopt the strategy we did. I could be wrong about my hypothesises about marketing, but my guess is that having the Midwest focus may help attract some members who are interested in what the state has to offer investment wise. The Ross School of Business is constantly partnering with Michigan companies, doing wonderful work expanding educational goals while getting involved with the companies around them. They advertise the heck out of these partnerships on their website, and why wouldn’t they? They look good! VVI hopes to replicate similar relationships with the companies we invest in, both to boost our application rates any maybe even get some positive press one day. “New Michigan Investing Club Only Focuses on Michigan Companies” sounds like a nice little news blip to me, but what do I know? Maybe I’m throwing all the marketing potential away by revealing it in a blog post, but it’s part of the reason why we chose Michigan, so I’m writing about it.
Investing in a specific region isn’t a new concept, and is actually still used today. Index funds like the Midwest Stock Exchange’s “Midwest Basket” allow for investors to own 20 of the biggest midwestern stocks with low commision rates. I actually got the idea to invest mostly in Michigan from a money management firm called “Mairs and Power”, which has been around forever. The company was founded in 1931, and their growth mutual fund started in 1958 (MPGFX is their ticker if you’re interested). They have a focus in the Minnesota/Upper Midwest region, and that strategy has worked for them marvelously.
I don’t believe that limiting ourselves to the Midwest is all that different from any U.S. equity fund or global equity fund. Each restrict the companies a fund can invest in by geography, and if anything I think we’re more open in certain ways by not limiting ourselves to large, mid, or small cap only as many funds do.
The more I thought about it, the more I convinced myself that adopting a similar strategy would be beneficial to VVI. In fact, I believe we even have additional reasons to pursue this strategy because we want the landscape to be narrowed down and we want some proximity to the companies we are investing in because unlike a mutual fund, we can’t afford to fly out and visit companies we are interested in. A company headquartered in, say, Farmington Hills is a lot easier to get to than silicon valley if we wanted to visit.
I’m trying to be very clear about what the club is. By the time all the members researched the club on their own, and certainly by the time of their interview, they should know what they were getting into, with all the “limitations” in place.
In Mairs and Power’s white paper on why Minnesota, they have this one little line I like a lot which reads, “We are neither arguing within these pages for a set of economic policy prescriptions nor are we beating the drum of regional boosterism.” I think the same applies for VVI. We aren’t saying that having a Michigan focus is better way to invest than any other way, but it works for us for all the reasons listed above.