How to avoid unintended concentration risk


Concentration risk can be defined as the risk of amplified losses that may occur from having a substantial portion of a portfolio in a specific investment, sector or asset class.

The Australian sharemarket is structurally prone to concentration risk; Grant Samuel Funds Management outlines the issues and some of the strategies to avoid unintended exposure to concentration risk.

The Australian sharemarket

The Australian share market is small by global standards, representing less than two percent of world markets. Small and dominated by a small number of large companies. In fact, when examining the S&P/ASX200 (ASX200), a common benchmark for constructing Australian equity portfolios, the top 20 stocks comprise approximately 58% of its market capitalisation.



A managed fund that uses the ASX200 Accumulation Index as a benchmark will generally have a portfolio skewed toward the largest companies in that benchmark.

For an active fund, this tendency toward the largest companies comes because the fund’s performance is generally determined by the size of that fund’s holding in those companies relative to that company’s weighting in the index.

When it comes to passive investment, either through a managed fund or an Exchange Traded Fund (ETF), the fund’s holdings are generally a replication of the relevant index.

Drill down a little further into the top 20 ASX-listed companies, and there is a significant sectoral bias toward financial stocks. The top four listed ASX companies are the big four banks – in order of market capitalisation, CBA, Westpac, ANZ and NAB. The other financial stocks rounding out the top 20 are Macquarie Bank (number 10), Suncorp (17) and QBE (19). Collectively, as illustrated in figure two, these financial stocks comprise more than 50 percent of the top 20 ASX-listed companies.

Coming in second place are resources companies (combined Materials and Energy), which comprise nearly 20 percent. Prior to the Global Financial Crisis (GFC), it was the resources sector that dominated the ASX200 and, in particular, the top 20.



How does this compare to global markets?

A global benchmark

The MSCI World Index, a common benchmark for global funds, both active and passive, is comprised of 1,652 stocks. At 28 February 2017, the largest, Apple, had a free float-adjusted market capitalisation of US$738.16 billion, with the smallest, just US$1.2 billion.

The top 10 stocks provide a somewhat more diversified spread than the ASX:


The top 10 companies make up 10.37% of the MSCI World Index; the three Information Technology companies, two of which are the largest in the index, make up just 4.32%. In other words, allowing for the vast number of companies within the index, it is more diversified than ASX indices at the larger end. However, it is interesting to note that each of these is a US based corporate; an index fund that replicates the MSCI World Index may be diversified from a sector point of view, but potentially less so from a geographic stand point.

The US experience

The S&P500® is widely regarded as the gauge of large-cap US equities. The index includes 500 leading companies and captures approximately 80% coverage of available market capitalisation.


Except for the inclusion of Berkshire Hathaway (and exclusion of AT&T), the top ten constituents of the S&P500 and the MSCI World Index are the same.

The United Kingdom

The FTSE100 is a market-capitalisation weighted index of blue chip companies and although the UK is home to some large companies, interestingly none are top holdings in the global index.


While oil and gas dominates the top FTSE100 companies by market capitalisation, overall they represent 11.91% of the FTSE100, closely followed by personal and household goods (11.55%) and banks (10.78%).

How might concentration risk manifest?

There are several ways concentration risk can manifest in client portfolios:

  • Intentional concentration your client may believe a specific investment, sector or geography will outperform and decide to invest a bigger portion of their investment money into that investment.
  • Unintended concentration – this may come from holding a range of investments that have similar asset, sector or geographic exposure; for example, a portfolio of blue chip Australian shares, an ASX-200 ETF and an actively managed Australian equity fund may result in significant concentration of the top 20 ASX-listed stocks.
  • Concentration due to asset performance – those investors who bought CBA shares at IPO in 1991 and still hold them have done well. The initial price was $5.40 per share, and the latest share price was $83.06 (at 22 March 2017). A parcel of 10,000 shares that cost $54,000 at IPO is today worth $830,600 and could easily comprise a much greater proportion of a client’s portfolio, particularly if dividends were reinvested. Given that the big four banks have each experienced similar growth, a portfolio of blue chips will be necessarily skewed to banks. In such a case, any risk factor that impacts banking stocks could have a negative outcome for such a portfolio.
  • Concentration due to correlation – some investments are positively correlated, which means that they tend to perform the same way in the same market conditions. This might be the correlation between asset classes – for example, growth assets such as shares and property tend to be more closely correlated than equities and the more defensive fixed income sector. Correlation may result from holding shares in the same industry; for example, an external impact that affects pharmaceutical companies, such as regulatory change, will be likely to affect the sector rather than one or two companies. Geography can also give rise to correlation – an economic downturn in a country or region will generally impact a range of investments in that region.

How can investors avoid concentration risk?

The best way to avoid concentration risk is to ensure portfolio diversification, across assets, sectors and geographies. Being aware of structural issues that can impact the composition of managed investments – such as the concentration of the top 20 stocks in the ASX200 – can help avoid concentration risk.

There are a range of investment options that can help to avoid concentration risk, including:

Smaller companies funds

Available both globally and domestically, funds focused on mid-cap or small-cap funds avoid the inherent skew towards sectors that dominate the large cap universe. In Australia, the S&P/ASX Small Ordinaries Index (Small Ordinaries) represents the small cap members of the S&P/ASX 300 Index, excluding those companies in S&P/ASX 100 Index; it covers approximately 7% of the Australian equity market capitalisation and its top ten constituents by market capitalisation represent 15.3 percent of the Small Ordinaries. The largest, Oz Minerals, is just two percent of the index.

There are several factors that make small caps attractive. These include:

  • Smaller companies are often under-researched by stock analysts and therefore potentially mispriced, presenting opportunities for astute investors to cherry pick the best opportunities.
  • Investing in a small cap company in the initial stages of its development, staying invested while it expands and grows, can potentially provide substantial returns. All companies had to start somewhere – even Australia’s top 50 stocks were once ‘small caps’.
  • Smaller companies are often the target of merger and acquisition activity, which is generally positive for the company’s share price.
  • As illustrated in Figure two, the ASX200 is dominated by financial and resource companies – small caps provide exposure to a more diverse range of industries. Some growth areas, such as health care or information technology, have greater representation outside of the ASX200.

Long/short funds

A long/short equity strategy holds both long and short equity positions. If the investment manager believes a company’s share price will appreciate, it can go long and buy shares in that company. Conversely, if the manager believes a company is overpriced or unlikely to prosper due to structural, economic or company-specific factors, they can go short and sell its shares.

A long short equity strategy seeks to profit from share prices appreciation above the index in its long positions and price declines below the index in its short positions.

There are two primary benefits from employing a long/short strategy:

  1. The investment manager can tap into underperformance of the market by identifying losers as well as winners. Traditional managers leave that information on the table as they can’t do anything with it. A long/short fund unlocks that potential and gets extra returns out of the ‘losers’.
  2. Increased diversification – because of the concentrated nature of the Australian equity benchmark, traditional managers are often forced to take concentrated positions. Rather, the combination of long and short positions potentially enables greater diversification which may help to mitigate risk, particularly in a volatile market.

Invest globally

Not only is the Australian share market concentrated, it is small by global standards, representing less than two percent of world markets. Investing globally can deliver access to a broader range of sectors and companies, which provides diversification benefits to investors’ portfolios.

Investment portfolios can easily fall prey to concentration risk. As long as there is an awareness of this potential, particularly in relation to Australian equities, investors can take steps to consider other investments that enhance portfolio diversification and reduce the risk of having too big an exposure to a specific sector, asset class or geography.


This article provides general information only and has been prepared without taking account the objectives, financial situation or needs of individuals. The information contained in this article reflects, as of the date of publication, the views of Grant Samuel Funds Management ABN 14 125 715 004 AFSL 317587 (GSFM) and sources believed by GSFM to be reliable. We do not represent that this information is accurate and com­plete, and it should not be relied upon as such. Any opinions expressed in this material reflect our judgment at this date, are subject to change and should not be relied upon as the basis of your investment decisions. All reasonable care has been taken in producing the information set out in this article however subsequent changes in circumstances may occur at any time and may impact on the accuracy of the information. Neither GSFM, its related bodies nor associates gives any warranty nor makes any representation nor accepts responsibility for the accuracy or completeness of the information contained in this article. Past performance is not a reliable indicator of future performance. Investing involves risk including loss of capital invested. ©2017 Grant Samuel Funds Management Pty Limited.

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