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Investments, Portfolio Construction

A straw house or brick house?

Australia’s home bias towards local shares is well documented. In fact, the “ASX 2017 Investor Study” shows 75 per cent of Australia’s share owners hold only domestic shares, compared to 11 percent who hold only international shares.

But what is perhaps less well known is the Australian bias towards a handful of popular local shares in financials, telecommunications, mining and retail. The top 10 largest Australian shares represent around 33 per cent of all SMSF trustee Australian equity holdings.

For many Australians, this is a noteworthy portion of their retirement portfolios reliant on the success of just a few companies. While in many instances these companies have performed well in the past, casting the net wider with a more broad-based exposure to Australian shares can help enhance returns and add greater value in the long run.

The risk of the narrow home bias

An examination of top-performing Australian shares over the past decade reveals some important lessons for investors.

Firstly, there’s no guarantee yesterday’s winners will perform strongly tomorrow. You need only look at the top mining stocks as an example. The hero investments for many Australians throughout the 2000s, the end of the mining boom saw a sudden decline in company values and the rewards being delivered to investors.

Secondly, the S&P/ASX 200 has historically proven itself as a more reliable source of returns when compared to the performance of many of the individual shares most popular with investors. This accounts for how market events affect sectors differently. For example, cyclical sectors like consumer and materials tend to perform strongly in improving economies, while defensive sectors like healthcare and utilities generally perform better in challenging times.

Third, a preference towards holding stocks already at the top of the ASX means investors can miss out on smaller capitalisation companies that can offer greater potential for rapid growth when compared to the more established players.

These lessons teach us that by holding a portfolio that includes stocks from across different companies and sectors, investors are less susceptible to a particular company result or sector change, while also allowing for the opportunity to capture the growth gains of smaller companies.

Why diversification is a must

No matter how hard we try, it’s not possible to predict tomorrow’s share market winners. But we can look to spread investments more widely over the Australian share market to help fill common portfolio gaps. The more investors spread their investments around, the less susceptible their portfolios are to one-time events that could result in significant losses.

While holding a portfolio of 10 to 20 shares can certainly help reduce risk through diversification, holding a portfolio of Australia’s 200 largest companies provides even greater diversification benefits, creating a solid foundation for an Australian share portfolio.

This is exactly what State Street Global Advisors had in mind when we introduced the SPDR S&P/ASX 200 Fund (STW), an exchange-traded fund (ETF) that gives Australian investors access to the entire S&P/ASX 200 in one simple trade. Many investors recognise the value of tracking the returns of the S&P/ASX 200 – STW remains Australia’s largest and longest running ETF.

Searching for greater exposure with an ETF can also carry another advantage for many investors. For those able to commit more time to managing their portfolio, actively picking direct shares can certainly make sense. However, for those with less time, outsourcing a greater part of the investment decision can make life easier.

Casting the net wide with an ETF may not be as exciting as picking out individual stocks. In fact, many investors tell us it’s the most boring trade they will ever make. But they also tell us it gives them the comfort of having their money invested more widely across the market than just in Australia’s largest companies.

While many Australian investors continue to rely on a handful of high-performing Australian shares for the cornerstone of their portfolio, taking a broad-based approach to wider exposure can enhance an investor’s ability to add value.

Meaghan Victor is Australia head of SPDR ETFs.

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