August 27, 2014

City-Based Investing: The LocalShares Nashville Area ETF (NASH)

A story came on the radio today about a year-old ETF called the LocalShares Nashville Area ETF (NASH) that tracks stocks on a hyperlocal level. Admittedly, I hadn't heard of this one before, but the idea intrigues me. Typically when we think of slicing and dicing our portfolios geographically, it's done at the national level. We Americans more often than not have a majority of our investments in American companies and diversify into a catch-all "international" bucket. This might be accomplished through a broad ex-US developed markets ETF like the iShares MSCI EAFE (EFA) or segmented a bit further by region - maybe something like the Vanguard FTSE Europe ETF (VGK). And of course broad emerging markets funds and investments that track individual country indexes like if you want specific exposure to China, Brazil, or some other fast-growth countries.

But that's really about it. It's usually Americans stocks vs. not American stocks for most folks. When it comes to American companies, we can find ETFs that help us segment in an almost infinite number of ways. You can pinpoint by industry, company size, investing style, portfolio weighting, and on and on. But why not break things down by region within the U.S.? It seems like just as logical of a way as any to organize investments. For example, rather than just investing in a tech sector ETF, why not one that focuses just on companies in the San Francisco Bay Area? Bloomberg a Bay Area Index, why not build investments off of it? Or what about something that tracks stocks based in the Sun Belt? Yes we've got real estate ETFs, but maybe some investors want exposures specifically to some of the fastest-growing states in the country?

We often invest in American companies out of a sense of patriotism, so I can see there being a market for investing in your particular area of the country. LocalShares has taken a stab at this strategy by launching their Nashville, TN-focused ETF. It appears the particular choice to focus on Nashville was born out of their management team's connections to the area. Although so far the fund remains small with about $7 million in assets as of the end of July. NASH's 0.49% net expense ratio seems fair given the very specific, niche exposure the it provides.

Despite the funds's modest assets, this idea is interesting. Consider that the Nashville metro area is only ranked 36th in the country, with over 1.7 million people. The New York metro area is over ten times the size and is a city with a global brand. If we make the (very) rough assumption that such an ETF could scale assets proportionally to the area's local population, then it seems like funds based on companies based in and around New York, Los Angeles, and Chicago might relatively easily be able to gather over $50 million each. It's fun to speculate.

Going back to NASH, it holds relatively few companies (23 according to Morningstar) and tilts relatively heavily to small cap stocks with modest mid and large cap exposure. LocalShares website says the portfolio weighting is, "based on a proprietary formula developed to account for positive earnings, momentum and valuation metrics." While the site goes on to claim the fund is passively managed, alternative fundamental-style weightings like this feel more active to me.

That said, the proprietary formula this ETF is based on results is the largest holding being Amsurg Corp (a 7.04% portfolio weight). Amsurg is valued at $2.6 billion, similar in size to LifePoint Hospitals (#2 on the list, 6.33% of the portfolio). Conversely, the third and fourth largest holdings (around 6% each) are far larger companies. HCA Holdings and Dollar General are valued at about $30 billion and $19 billion respectively, much bigger than the largest two holdings. Ultimately, this ETF is very much weighted to the health care industry (over 36% of its holdings).

I don't have faith in my ability to pick stocks, and that goes for picking individual sectors or countries, but for those that do, this concept seems to hold a lot of promise. Small cap companies are often more tied into local or regional economies, so investors with a reason to favor particular areas of the country might have a use for smaller geographically targeted ETFs in their portfolios. Hopefully we'll see more of these to come as the industry continues to innovate.

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