Is it time to lose concentration in your share market portfolio?

Share market portfolio lose concentration ASX investment stocks
Investors runs the risk of becoming heavily weighted in a particular sector, increasing the risk profile of their portfolio.

One of the traps most investors are keen to avoid is unwanted share market portfolio concentration.

It is a problem Australian investors are particularly aware of because we have one of the most concentrated share markets in the world.

For example, if you buy an exchange traded fund covering the ASX 200 such as State Street’s SPDR ASX200 ETF (ASX: STW), you are going to be heavily exposed to the two big resources companies BHP (ASX: BHP) and Rio Tinto (ASX: RIO) and the big four banks, ANZ (ASX: ANZ), Westpac (ASX: WBC), Commonwealth (ASX: CBA) and National Australia (ASX: NAB).

Too much in banks and resources

Together those six companies in just two industries make up almost a third of your investment, which can be a big problem if there is a problem in one of those industries – which has actually been the case at different times in the past year for both mining and banking.

The concentration risk can become even greater if the unwitting investor has other direct investments in the same bank and mining companies and particularly if they also own other investments with a high proportion of the same companies such as the big listed investment companies Australian Foundation (ASX: AFI) or Argo (ASX: ARG).

The dangers of poor returns due to concentration can come as quite a surprise for some investors, given that they may feel they are diversified across the whole market but the problem arises when you have a few heavyweights in the same sector hogging the “top of the charts’’.

Beware technology concentration

There is another new concentrated portfolio trap that may be catching many Australian investors unaware because it has developed quite quickly.

Investing offshore is one of the keys to having a good, diversified portfolio mix and until recently, exchange traded funds covering the S&P 500 (such as ASX: IVV) were much better diversified than ETFs covering the ASX 200.

Not only does it feature some shares in each of the 500 biggest US companies, the US share market is much more diversified across more sectors than our market and provides exposure to the largest market and companies in the world.

However, a long bull market has changed all of that and the S&P 500 is now highly concentrated on technology stocks – which is one of the reasons that the overall US market indices have reacted so vigorously to events such as Apple’s lower iPhone sales in China.

From highly diversified to concentrated

When the US market was at its bottom back in 2009, the largest weighting in the S&P 500 was oil company Exxon Mobil Corp, which made up just 5.6% of the index.

It was followed by a range of companies with weightings around the 2% mark in different industries such AT&T, Chevron, Johnson & Johnson and Procter & Gamble.

That situation has now changed dramatically with the big technology FAANG stocks (Facebook, Amazon, Apple, Netflix and Alphabet’s Google) now dominating the top of the charts, with many smaller technology stocks also in the index.

The biggest stock on the index is also a technology stock – Microsoft – which makes up around 3.7% of the index and another large company at the top of the index in Berkshire Hathaway that is also Apple’s largest shareholder.

FAANGs to the fore

All told, technology stocks – which can be quite volatile – now make up around 22% of the S&P 500.

That is not quite as bad as the ASX 200 but it is still a much larger sector concentration than S&P 500 investors have had to deal with in the past.

In a situation that is similar to Australia, many US managed funds will also now feature a lot of technology stocks, given that they are trying to match or better the S&P index.

So many Australian investors might also find they are subject to some unexpected concentration on their US ETF investments as well as their Australian ones.

Ways around concentration risk

Not all investors want to get rid of concentration risks.

For example, many Australian investors might be happy to add some extra global technology exposure given the lack of quality technology investments available in Australia.

What is important is to recognise and accept whatever concentration risk is there rather than be ambushed by it later.

If you do want to avoid concentration risk, there are some ways around it.

One way is the old-fashioned method of selecting individual stocks that might better represent where you see the market going.

So, for example, in the US market you might decide to back the oracle of Omaha, Warren Buffett, and buy Berkshire Hathaway stock as a curated proxy for the US market.

Sure, you might be getting a strong exposure to Apple but otherwise Berkshire Hathaway is famously underweight in technology stocks and Warren Buffett also has one of the best investment records you could hope for and has an in depth knowledge of the US market that would be hard to match.

You could also choose a full DIY strategy of selecting lots of individual stocks – something that is much easier to do now that many Australian brokers can help you purchase US stocks directly at reasonable brokerage.

If you wanted to stay with passive strategies, you could also supplement a vanilla S&P 500 ETF with some sectoral ETFs that might have more appeal and serve to dilute the exposure to technology.

Similar choices are available in Australia.

You could choose to split your investment between different ETFs to dilute the mining and banking exposure, you could select your own portfolio of individual stocks or you could rely on an experienced, low cost fund manager such as AFIC (ASX: AFI) or Argo (ASX: ARG) to do the stock selection for you.

Of course, it is also possible to mix and match any of these strategies.

The important thing to remember in all of these situations is to recognise concentration risk and either accept it or strategise around it but to never be surprised when an individual sector tanks and takes your investment down with it.

John is a highly experienced business journalist and formerly chief business writer for the Herald Sun. He has covered Federal politics in Canberra, was Los Angeles Bureau chief for News Limited and was also chief of staff for the Herald Sun. He has covered a wide range of small and large cap ASX stocks and has a special interest in mining, technology and biotech.