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The Hidden Dangers Of 'Comfortable' Investing

Investing in the most widely held stocks in the Australian market is often viewed as a low risk approach to investing.

By the very nature of these companies, they are well known, very large and typically well-capitalised businesses. They have been successful in their past endeavours, efficiently executing strategies that have enabled them to become household names. Their size and familiarity offer comfort to the investor. The fact that they are well owned ensures a positive disposition will be held by the majority, and this favourable opinion further encourages the belief that investing in these stocks is both safe and sensible.

Somewhere along the way though, future earnings and price can become secondary considerations to being invested in these dominant businesses. Analysis of the Australian market makes clear that it is heavily overweight a small number of dominant companies as compared to most other international indices. Just two sectors, financials and resources, make up more than 50% of the ASX 200 Index and approximately half (49.3%) of this Index is comprised of the largest 15 companies. These 15 companies are the most widely held in the domestic market, with an average market capitalisation of over AU$57bn and a combined market capitalisation of approximately AUD$859bn. They make up the core part of most superannuation equities portfolios, whether through managed funds or self-managed accounts.

ASX 200 Index concentration

Source: Iress

While passive portfolio management is gaining in popularity around the world, in Australia this means having close to a 50% exposure in just fifteen stocks, and around the same exposure to just two sectors (financials and resources), without a consideration of the merits of these investments.

Many of these companies, and the segments of the market in which they operate, are seeing some of the tailwinds which have supported them over recent decades weaken. In some cases, these tailwinds have even become headwinds. For example, expensive residential property (the big banks), competition (the supermarkets and Telstra) and shifting demand supply dynamics (commodities) may well lead to a reversal in earnings momentum over time.

While we do not wish to oversimplify the merits, or otherwise, of investing in these highly successful companies, it is hard not to conclude that a portfolio largely exposed to the most popular stocks in the Australian market is one that faces both concentration risk and exposure to parts of the economy which may face a significantly less favourable environment in the coming years. While investing in these businesses may feel comfortable for many, the question that could be asked is whether comfortable investing is sensible investing.

For more product information on the Auscap Long Short Australian Equity Fund please click here.

View More Articles By Tim Carleton

Tim - Co-Founder of Auscap Asset Management

Tim has 13 years' experience in the financial services industry. From 2007 to 2011 he was an Executive Director at Goldman Sachs where he was responsible for managing an Australian equities long/short portfolio using Proprietary funds. Prior to 2007 he worked at Macquarie Bank within the Investment Banking Group. Tim is a CFA charterholder, a CMT charterholder, a Senior Associate of FINSIA, has a Bachelor of Laws (Hons) from the University of Sydney and a Bachelor of Commerce from the University of Sydney.

DISCLAIMER: This article contains information that is general in nature. It does not take into account the objectives, financial situation or needs of any particular person. You need to consider your financial situation and needs before making any decisions based on this information. Auscap Asset Management Limited (ABN 11 158 929 143, AFSL 428014) (Auscap) is the responsible entity of the Auscap Long Short Australian Equities Fund (ARSN 615 542 213) (Fund). A Product Disclosure Statement is available for the Fund and can be obtained at www.auscapam.com/auscap-fund/pds/ or by calling Auscap on +61 2 8378 0800. A person should obtain and consider the Product Disclosure Statement before deciding whether to acquire, or to continue to hold, units in the Fund.



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