Getting FOMO by only investing in the ASX. Whats your diversification strategy?
Australians love to invest in shares. With 33% of the adult population owning shares, we are # 2 in the world when it comes to direct share investments.
When it comes to investing in shares, we generally only invest in the ASX. Only 13% of share investors held international shares. Even the index investing folks focus on Exchange Traded Funds ("ETFs") like VAS, IOZ and STW - tracking the ASX 200 Index.
There are issues with investing with such a strong home bias - lack of diversification.
Most people talk about the lack of geographical diversification - having all your investments in Australia. Vanguard research shows that owning international stocks can reduce the risk of your portfolio. In this blog, we came to similar views that 30%-50% global shares can maximise risk reduction for your portfolio.
Another issue is the concentration of industries on the ASX. The Australian market doesn't have enough companies in a few high growth industries. This means sector diversification is a major problem. You are missing out on growth industries by only investing in Australian stocks.
When you think through a diversification strategy for your investment portfolio, it's worth thinking about investing in international markets.
So much concentration
The core issue is dominance of banks and miners on the ASX.
The chart above shows the industry breakdown of the Australian stock market. When you compare that to the Global market and the US market, you can see the key differences:
- ASX is really overweight in Financials. They are approximately 50% of the entire market compared to around 20% for the Global and US markets;
- ASX is also overweight in Materials (i.e. Mining) at 15% of the market, compared to 3% - 5% in the Global and US markets;
- ASX is underweight in three sectors - Consumer Discretionary, Health and Information Technology
Why is this a problem?
Lack of sector diversification
It is no secret that different industries have different growth and performance. The chart below shows the performance of each industry on the ASX for the last 10 years.
The Financial sector cover banks, listed real estate and insurance. It accounts for nearly 50% of the entire market. In the last 10 years, the sector has done well in Australia, achieving 9.7% average return per year.
But what is the outlook of the Australian Financial sector? The Big 4 banks make up 30% of the entire Australian stock market, and 60% of the Financial sector. Apart from ANZ, three of the Big 4 make more than 80% of their revenue from within Australia. The sector is very tied to the Australian economy and the housing market.
The Materials sector is mainly the large miners like BHP and Rio Tinto. The sector has been struggling lately. In the last 10 years, it achieved 3.8% averaging annual return, barely higher than the return from a term deposit.
Missing out on growth
Another major concern is with the industries that Australia is most underweight. The ASX is 9% - 19% underweight in three industries: Consumer Discretionary, Health and Information Technology. These three have performed very well in the last 10 years.
Cool Consumer Companies
Consumer Discretionary is the sector that cover companies like Nike, Starbucks and McDonalds. The Aussie versions are JB Hi-Fi and Harvey Norman. This sector only makes up 4.0% of the Aussie market, compared to 12.9% in the US and 13.5% Globally.
Aussie Consumer Discretionary companies are much smaller. They have also struggled in the past 10 years providing only 2.3% average annual return. On the other hand, US Consumer Discretionary companies have provided an average annual return of 10.5%. This has beaten the broader Australian market by 2.2% every year!
Healing the World
A similar story is played out with Health & Healthcare. The sector is only 6.0% of the Aussie market, but 15.6% of the US and 13.7% of the Global market. Health is a sector that has done really well in the past decade. In Australia, it provided averaging annual return of 16.4%. US health companies achieved 11.3% return over this period, beating the broader ASX 200 by 4.1% every year!
But perhaps the biggest issue with the composition of the ASX, and something close to my heart, is the lack of Information Technology companies. The sector is only 1.0% of the Australian market, but a whopping 19.8% of the US and 13.7% of the Global markets.
We all know about the incredible growth of companies like Google, Facebook, Apple, etc in the US. This has driven a 9.3% average annual return to the US tech sector in the last 10 years. Easily beating the ASX 200 by 2.0% every year.
Feeling the F.O.M.O.? There are solutions
If you want to invest in some of these higher growth sectors globally, there are options for you. Large online stock brokers are making it easier and cheaper to buy direct shares in large US companies like Amazon, Google, Facebook. NAB Trade is offering international trading from $15 per trade.
But whenever you invest in a company, you should do a lot of research. Stock picking is a very hard game. Not only do you need to invest in a good company, you also need to invest in that company at a good price. If you think you can beat sophisticated hedge funds in valuing companies, then good luck!
In our view, the smarter option to implementing this diversification strategy, and investing in global stocks, is investing through ETFs. Rather than pick stocks, pick markets. Here are some ideas on getting into international shares through ETFs:
- to invest in the US market which is around 50% of Global stock markets, you can look at VTS, SPY or IVV;
- to invest in the largest listed companies around the world, you can consider VGS, IOO, UBW;
- to narrow in on a specific industry like the US health sector (see IXJ) or US technology sector (see NDQ)