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Aussie investors exposed to concentration risk

Glenn Freeman  |  16 May 2017Text size  Decrease  Increase  |  

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An over-emphasis on local assets leaves Australian investors vulnerable to concentration risk, and ignores fundamental investment philosophy around diversification.


For all its strengths, Australia's investment landscape is widely recognised as being quite concentrated. The Australian securities market is small by global standards, representing less than 2 per cent of world markets.

It is also dominated by a small number of large companies, with the top 20 stocks comprising almost 50 per cent of total market capitalisation.

Recognising the potential concentration risk this represents, Australian investors would be wise to consider diversifying their portfolios to include some international exposure. Of course, a subscription to Morningstar is a good place to start.

Exchange-traded funds (ETFs) are a very popular, cost-effective way of investing internationally, without pursuing the costly and often complicated process of investing directly in foreign companies.

The need for greater diversification among Australians' investment portfolios is a key reason for the strong uptake of ETFs.


Exhibit 1: Australian ETP market and Morningstar coverage (AUD billions), Apr-2012 to Mar-2017


Source: Morningstar Direct


"In just one or two trades, you can buy an entire world of global equities, for example, on the ASX. So, that's the big one; diversification is one [reason for the popularity]," says Jon Howie, head of iShares Australia.

"Simplicity is another. ETF investors, and investors generally, are realising that ETFs are a great way to improve the simplicity of their portfolios rather than picking individual companies or trawling through lists of managed funds."

Highlighting the potential risk posed by concentrating too heavily on domestic-based assets, he also refers to Australian currency trends as driving demand for international investment.

"The weakening Aussie dollar ... [has] been a real benefit for investors, who saw what was likely to occur and were smart enough to actually invest internationally as the Aussie dollar started to weaken.

"Those ETFs that give investors access to overseas markets are probably going to continue to be one of the biggest areas of growth for the ETF market locally on the ASX," Howie says.

He believes the international market will continue to represent a much bigger opportunity for investors generally, "to access the opportunities overseas which are overall much bigger than the opportunities locally in Australia".

SMSFs underweight global exposure

Australian Tax Office figures indicate less than 1 per cent of Australian self-managed super fund (SMSF) assets are invested directly overseas. While the term "direct" is important here--this figure doesn't include international exposure achieved through investing in ETFs or other vehicles--it highlights trustees' emphasis on domestic assets, with SMSFs particularly exposed to direct property.

"We have a sector we believe is massively out of step with the accepted theory on asset diversification,", says Andrew Alcock, managing director of separately-managed account provider HUB24.

Australian Prudential Regulation Authority (APRA) regulated super funds have an international asset exposure of around 24 per cent.

"It's out of whack in terms of well-adopted investment theories on the principles of diversification as followed by the professionals, [which are] not echoed in Australian SMSFs," Alcock says.

He believes SMSF investors are underexposed internationally for various reasons, including the complications of accessing foreign markets, the cost of foreign currency settlements, and the difficulty of obtaining relevant information and legal recourse overseas.

Alcock sees an overexposure to Australian assets as a problem, because the local market is characterised by a lack of diversification, with financials and materials accounting for around 66 per cent of GDP.

Domestically listed IT and healthcare companies only account for 9 per cent of the market, compared to 27 per cent of global markets.

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Glenn Freeman is a senior editor at Morningstar.

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