Is your portfolio overweight?

In 1841, well before multi-skilling had entered the vernacular, Scottish poet, journalist, anthologist and songwriter Charles Mackay published Extraordinary popular delusions and the madness of crowds. It was later claimed that he exaggerated the impact of tulip mania, but Mackay was onto something. Together, people are more capable of damaging and ill-conceived behaviours.

About 155 years later, then Federal Reserve Chairman Alan Greenspan spoke of ‘irrational exuberance’ in financial markets, a comment designed to quell their eagerness. Being rational irrationalists, when Greenspan made money cheaper the problems just got worse.

The counter-argument came in 2004 when James Surowiecki published The Wisdom of Crowds: Why the Many Are Smarter Than the Few. Using data entered by members through the My Stockwatch section of the website, we’re going to put Surowiecki’s theories to the test.

After aggregating the data, minus names and any other identifiers to protect your privacy, we established what stocks are most popular amongst members and to what extent members abide by our portfolio allocation recommendations.

The conclusions? In our little corner of the universe, the wisdom rather than the madness of crowds wins out.

There are problems with the dataset, though. Members that use the My Stockwatch facility may not be an accurate reflection of our membership base as a whole; some portfolios may not be complete, affecting the stats they produce; and data may be incorrectly entered. But there are some general lessons we can take from the exercise.

Table 1 shows the top 20 stocks held by the almost 2,000 people that use the My Stockwatch facility. With the exception of BHP Billiton, every other company in the top 10 has been a recent buy recommendation. In fact, that’s generally true of most of the list.

The other side of that advice – the sells – is also reflected in the list. Having first advised members to sell Rio Tinto in November 2010 (Sell – $83.65), typically a long-standing holding in most Australian investors’ portfolios, most members appear to have followed that advice. The same goes for other stocks we’ve avoided like Qantas, BlueScope Steel and the recent spate of subordinated notes offers, which simply don’t make an appearance.

Conditional advice

But members’ propensity to act on advice to buy or sell seems conditional on the size of the company. Some of our most profitable recommendations of recent years have been 4WD accessories company ARB, Flight Centre and insurance group IAG. None of these companies made it into the most popular holdings, although that’s not to say they should.

But it does suggest that the Nifty 50/50 approach adopted two year ago, where we committed to cover the top 50 stocks and our 50 best ideas, is the right one. Whilst we’re in the midst of a sweep of the ASX 300 in the search for value, this will remain our focus.

It’s understandable some members, especially those investing for income, want to stick to the larger blue chips. But if you’re in a position to invest in smaller growth stocks but haven’t previously considered doing so, it might be a time to review that policy, especially with stocks like Computershare on the current Buy list.

Now to the caveat: Having examined the average portfolio weightings for the big banks and miners, it appears that some members have a greater exposure to these sectors than we recommend. With the recent price increase in the big banks, that’s even more true. So, if you haven’t checked the weightings of the stocks in your portfolio recently, now might be a good time to do so.

We recommend that you have no more than 10% of your portfolio in the big banks combined and no more than 5% in BHP and 4% in Rio Tinto. Even accounting for the unreliability of the dataset, some members have too much of their portfolio invested in the big banks and miners.

The same goes for one-time Strong Buy, QBE Insurance. It’s the most widely-held stock but has a worryingly high average portfolio weighting of 19%. Even accounting for a large margin of error in this figure, please check the level of your exposure to this stock. QBE is heavily exposed to Australian housing through its mortgage insurance division. If you hold this stock and any of the big banks, you’re doubly exposed.

The data also reveals that a few stocks on which we’ve had sells or avoids, including AMP, AGL Energy and Spark Infrastructure also feature in the list. There aren’t hundreds of members that retain these stocks but if you do, please reread our latest research to understand why we suggest you sell them.

Portfolio limits are a blunt tool and aren’t necessarily appropriate for every member. Confident, experienced investors especially may find them somewhat limiting. The ultimate test is how you feel after you’ve assessed and considered them. So, please check your portfolio weightings and make sure you’re completely comfortable. If not, please adjust them accordingly.

If you’re not yet using My Stockwatch, there are good reasons for doing so. Set up is straightforward; enter the stock code, quantity and purchase price of each stock you own and you’re done. Then you’ll be able to monitor the value of your portfolio without having to log into your broker. Plus you’ll get email alerts each time we publish research on the stocks you're interested in.

Best of all, My Stockwatch automatically calculates the weighting of each stock in your portfolio and compares it with our recommended weighting and current recommendation; an ever present reminder of when your portfolio is getting a little out of whack.

For that reason alone, it’s worth the effort. Set your portfolio up here and please let us know of any improvements you’d like us to make to this aspect of our service in the comments facility below.