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Falling Australian share market – The power of diversification

When it comes to the share market it is fair to say it has been an “interesting” last 12 months, with the domestic market peaking at around the end of April last year (All Ords approx 6,000) and then a marked decline since then to bob above and below the 5,000 mark (over the last few months). As a Hudson adviser when reviewing members finances I have had the advantage of seeing a broad spectrum of returns for different individuals with different financial arrangements. What has been clearly evident to me has been that those with very large exposures to Australian shares, and more specifically blue chip Australian shares, have faired the worst.

It has been documented many times that Australian investors have a “domestic bias” when it comes to investing, i.e. they tend to overweight Australian shares and in many instances have no global share exposure at all. This could largely be due to a level of trust and familiarity – you shop at Coles and you buy Wesfarmers, you bank with ANZ so you buy ANZ shares. Furthermore we know more about them, we may see articles about them in the paper or on the news. Bottom line, information on these companies is easier to locate and easier to digest than if investing in a company overseas. Ignoring global share exposure is especially prevalent in Self-Managed Super Funds:

 SMSFs with $1mil to $2 mil in assetsSMSFs with $500k to $1 mil in assetsSMSFs with $50k to $100k in assets
Australian Listed Shares30.6%28.9%23.9%
Cash and Term Deposits31.7%33.7%52.1%
Non-residential property11.3%9.9%1.7%
Overseas Shares0.28%0.26%0.42%

Source: ATO SMSF Statistical Report June 2014

As you can see SMSF investors predominantly invest in the two things they know and understand; Australian shares and cold hard cash.

Sadly, in terms of returns, it has become evident that global share market returns have continued to dominate over those of the domestic share market every year since 2011:

YearAustralian SharesInternational SharesInternational Shares Hedged

Source: Vanguard

As well as missing out on potential higher returns, the key risk for me in overweighting Australian share exposure is that it is likely to significantly increase the level of volatility that Australian investors are experiencing. This can daunting for many investors and may even cause them to exit the market and realise significant losses. Furthermore it may cause significant problems if you are about to retire and depend on your funds as a source of income. I.e. just when you come to access some of the funds, they may have fallen 15% and again you are forced to effectively lock in the loss when selling them down.

If you have felt that your shares/super portfolios have suffered more volatility in the last year than you are comfortable with, diversification could be the key to ensuring this does not happen again.

The previous table demonstrates how global shares can deviate significantly from the returns of the Australian share market, however even diversification within the domestic market itself could reduce overall volatility. “Small Cap” funds for example do not by any means necessarily move in tandem with say, the ASX200 (a composite index of the largest 200 companies in Australia). One particular small company fund I use under our approved platform returned over 26% in the 12 months to Dec 31st 2015, compared to just 2.3% for the ASX200 based index fund I use. Where the larger companies in Australia have had a very trying year, plenty of smaller companies have flourished, and a good fund manager will try to target those companies.

There is even a further level of diversification away from the share markets in the form of property and infrastructure. Again, these markets do not necessarily move in tandem with the share market and as such would “iron out” overall volatility in your portfolio if included. A property-based fund used for many years by Hudson advisers has returned over 14% over 2015 compared to the 2.3% of the domestic share market.

We use managed funds to help members invest in shares, and likewise a retail superannuation platform to help members invest their super. We do this because the investments are diverse and many of the fund managers have a proven history of strong returns. However, if managed funds / super platforms are not for you, there are still ways and means to gain exposure to a diverse range of global funds and/or property based funds, directly over the exchange, in the form of Exchange Traded Funds (ETFs) and Listed Investment Companies (LICs).

If you limit yourself to Australian shares you increase your potential volatility, just the same way as if you limit your Australian share exposure to four or five (or even 10) blue chip Australian companies. I certainly urge all those who are within five years of retirement to strongly consider whether their investments are diverse enough, so as to avoid hitting retirement at a time when the domestic share market may have experienced recent losses.

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