Regardless of where they live, investors have a significant opportunity to diversify their equity portfolio outside of their home market. Despite the opportunity, investors typically maintain a significant “home bias”, ie, higher allocations to their home country than the market capitalisation weight these represent in a global equity index.
This article examines how a portfolio predominantly allocated to Australian equities (proxied by the MSCI Australia Index) stands to benefit from a greater breadth of global opportunities (proxied by the MSCI World Index).
Global equities provide exposure to a diverse range of countries, sectors and industries which can serve as a hedge against specific country, sector or industry risk. Australian equities are highly concentrated at both the sector and individual security level. The Financials and Materials sectors alone constitute nearly 60% of the Australian equity market compared with 20% globally (Chart 1). Diversifying exposure globally provides investors the opportunity to participate in regional markets which are performing differently, thereby further diversifying sources of risk and return.
Chart 1: Sector concentration MSCI Australia vs MSCI World
Source: Bloomberg, based on GICS classification as of May 31,2019.
Within Australia, the top 10 stocks1 comprise over 50% of the market capitalisation weighted index, while the largest four banks2 are nearly 31% of the benchmark. Furthermore, the top five stocks comprise more than a third of the index while the bottom third of the index is comprised of 55 stocks (see chart 2).
Chart 2: Stock concentration in MSCI Australia
Source: Bloomberg, June 2019
Anchoring stock selection and portfolio construction purely to the Australian equity index increases overall risk exposure, leaving investors overly reliant on a handful of return drivers, in addition to further limiting access to diversifying opportunities.
Due to the concentrated nature of the Australian equity market, over the trailing 10-year period Australian equities have realised over 30% more volatility and on average over 60% greater drawdowns (Chart 3).
Chart 3: Trailing 10-year average drawdown risk
Source: eVestment, monthly returns. 10-year trailing period as of May 31, 2019.
An allocation to global equities would have significantly improved both risk and return over the trailing 10-year period as shown in Chart 4). A portfolio comprised of 75% Global Equities and 25% Australian equities would have realised 30% less risk over this period compared to a portfolio comprised of 100% Australian equities.
Source: World (MSCI World Index), Australia (MSCI Australia Index). Chart based on monthly trailing returns, eVestment. As of May 31, 2019.
2 Includes Commonwealth Bank of Australia, Westpac Banking Corp, Australia and NZ Banking Group, National Australia Bank Ltd and Macquarie Group. Source: MSCI Australia Index, Bloomberg as of May 31, 2019.
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