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Two Diversification Tactics You should Consider

Whilst all markets have shown some good signs in recent times we should not get complacent, a rising tide lifts all boats but beyond that there are still stark differences across sectors and markets.  

As we repeatedly advise, Diversification is one of the primary tools of risk management. 
Too much of anything is an increased risk (just think BHP before GFC versus now).   Gone are the days where you can load up on Australian banks and resources and expect to be doing well. Asset Allocation and Diversification is more paramount than ever in seeking steady balanced investment returns. 

Two Diversification Tactics you may not have considered ?

1. Boost Global Exposure

Investing in our own backyard ONLY, has almost been a past time for Australian investors.   Pre GFC days a swag of bank and mining shares was stellar performing portfolio  – not so today.  

The case for boosting Global exposure has already been well covered by adviser Michal Park in this Hudson Report “Australian versus Global Share Returns”
The point of my article is purely about diversification so rather than repeating much of what Michal has already said, take a look at the following table of  the top 4 stock of Australian Index versus that of the Global Index.  

Australian Index Percentage of Index Global IndexPercentage of Index
Commonwealth Bank9.04%Apple2.25%
ANZ Bank5.40%Amazon1.11%
National Bank5.29%Facebook0.98%
 26.45% 5.76%

Source – Colonial Index Funds (30/6/17)

2. Diversifying Within Australia– Consider Ex- Top 20 Stocks

EX20 stocks/index can be considered more of a “MID-CAP” index with stocks ranked from number 21 to number 200, based on their market capitalisation.   

You could consider this to be the ‘Goldilocks’ part of our market. The stocks are big enough to have overcome the early growth hurdles typically faced by small companies, yet not too large that most of their growth potential is already past.   

  • The average market cap of stocks in this sector is around $4 billion, compared to an average of $46 billion among stocks in the large-cap S&P/ASX 20 Index.  
  • The Small Ordinaries Index, which covers around 200 stocks listed on the Australian Securities Exchange, ranked from number 101 to number 300, has an average market cap for stocks in this Index is a (still considerable) $1 billion. 

The top-heavy nature of our TOP 20 stocks on the Australian market reduces our diversification in most Australian investment funds (especially in our super) due its dominant weighting in the index.   

  • The Top 20 stocks account for a whopping 54% of the S&P/ASX 300’s market capitalisation. As a result our big stocks (banks & miners in particular) have a big influence on the performance of our primary Index.
  • By comparison, EX20’s Index has only 13% exposure to financials, compared to 37% for the broader S&P/ASX 200 and 56% of the ‘Top 20 Index’.   

In times of major structural change – such as when commodity prices are slumping or finance sector is underperforming or the internet is disrupting traditional business models in some sectors The ex-20 sector has shone a light on our market outperforming both the largest market-cap stocks in and smaller cap stocks.

Source: Bloomberg.  
Source : Beta Shares 22 November 2017.   
Note you cannot invest directly in an indexPast performance is not an indication of future performance 

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