Investors in the Australian Securities Exchange (ASX) are increasingly likely to be exposed to concentration risk as valuations in a handful of stocks have climbed, according to a global investment manager.
Allan Gray Australia managing director and chief investment officer Simon Mawhinney said the near-record recent multiples in these stocks had skewed the market, causing people to overlook cheaper equities.
“The recent period of strong share market performance and price-insensitive investment flows appears to have led to significant market dislocation and stretched fundamentals,” Mawhinney said at the recent Allan Gray Australia and Orbis Investments Investment Forum.
“Trade tensions, populist politics and monetary policy have become front-of-mind distractions, shifting attention away from long-term fundamentals.”
He noted the ASX was following a trend seen in the S&P 500 when at its peak in December its cyclically adjusted price-to-earnings ratio was 36.5 times, compared to its historical average of 21.8 times, and while the ASX 300 was trading at lower levels, there was a concentration around stocks that have driven the Australian index higher.
Eight stocks – the big four banks and Wesfarmers, Goodman, Aristocrat and Macquarie Bank – produced 85 per cent of the index return last calendar year, but represented only 28 per cent of market capitalisation, repeating a pattern seen over the past three years, he pointed out.
He added while the weight of these eight stocks in the ASX 300 has become disproportionate, the remaining 292 companies have delivered modest to very low returns in aggregate and are much cheaper, but are probably being inadvertently overlooked by passive investors.
“The Australian index is now extremely concentrated. Passive index investors are currently knowingly or unknowingly allocating a huge part of their exposure to banks, which are trading at eye-watering valuations,” he said.
“A purely passive approach may leave you exposed to heightened valuation risks at the moment.”
Orbis Investments head of global investment Simon Skinner added while investors have been rewarded for buying size, growth and familiarity in both Australian and international markets, that strategy would not hold into the future.
“These messages – buy at any price, big is good and persistent US exceptionalism – have sunk deep into the system. They are shaping how portfolios are built, how benchmarks are tracked and how stories about markets are told,” Skinner said.
He said Orbis research showed the performance of equity markets over the past 10 years compared to the past 50 years was an outlier and contributed to a global index concentrated in the US and a handful of stocks rather than a diversified benchmark.
“Diversification isn’t about holding more stocks. It’s about holding different ones,” he said.
“This isn’t about avoiding the index. It’s about owning businesses that offer what the index cannot: independent drivers of return.”
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