Regardless of where they live, investors have a significant opportunity to diversify their equity portfolio outside of their home market.
Australian investors have tended to build portfolios that are highly concentrated in the domestic equity market. The Australian market has on average represented roughly only three percent of the MSCI World market cap weighted index.
This piece 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 Sector Diversification
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
Australia's Concentration Risk
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
Drawdown Benefits of International Diversification
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
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.
Chart 4: 10-year Risk vs Return Portfolio Characteristics
Performance Cost of Home Bias
Even in those calendar years where the MSCI Australia Index has outpaced the MSCI World Index based on total return, the vast majority of top performing stocks were based outside of Australia, underscoring the opportunity a global manager has to potentially add additional alpha to a purely (or largely) domestic Australia portfolio.
The chart below highlights the opportunity cost of foregoing exposure to the global equity universe. In all years since 2009, nearly 100% of the top 50 performing stocks in the MSCI World Index were domiciled outside of the Australian market.
Chart 5: Percentage of Top 50 Stocks that are Non-Australian
Global Equities & The Opportunity for Alpha
The below chart shows that both the median and top quartile Active managers earned significantly more Alpha for their clients as compared with those constrained to the U.S. market.
Chart 6: Global vs Domestic Manager 10 Year Excess Returns
That said, all investing demands diligence; it must be done right or not at all. Thus, a consistent and thoughtful approach is required. QS Investors takes pride in providing clients a systematic and rigorous process with which to engage the global equity market.
Legg Mason QS Investors Global Equity Fund
Legg Mason QS Investors Global Responsible Investment Fund
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