Sector bias and asset allocation

If you follow share markets on a regular basis, you might have noticed that the Australian share market has outperformed international markets over the past decade. With large developed markets providing low returns over this period, our mantle of being called the “lucky country” certainly seems justified.

The natural question investors would ask is "why should we invest anywhere else?" There’s certainly some validity in this, but if we go further into the asset allocation, we are able to better determine the risks and reasoning for this outperformance.

Asset managers and financial advisers preach that good asset allocation is the biggest key to long-term investment success. However, looking at the ASX200, we realise immediately that our banking and mining and resources sector account for 70% of our index. In comparison, the widely followed S&P500 only has 30% in these two sectors, while globally it only makes up 40%.

This large bias is the key reason for the outperformance over the past decade as both of these sectors had strong returns. This bias also provides greater risks and when the commodities boom ends and/or our housing sector slows down, investors will truly need to think twice about having their money so heavily invested in these two sectors.

This is one of the big reasons why it is still important to allocate a certain percentage to international markets. No one knows when our “lucky” run will end, but to be certain, by the time you find out, you will have missed the boat.