Why Stock Indexes Can Be Under-Diversified

In 1976 John Vogel, founder of Vanguard Investments, began offering the first US-based Stock Index Fund. This marked the first time that investors and their advisers could easily purchase large collections of individual stocks at relatively low cost. This simple innovation would, in time, go on to change both the way people invest and the financial industry at large. Today, it is estimated that over $10 trillion of assets are invested in index funds (1).

While index funds have greatly simplified the process of buying many stocks at once, they are not necessarily an ideal 1-stop-shop for investors. This is because, as attractive as the idea of buying one product and forgetting about your investments until you need them may seem, doing so will likely leave you dangerously under-diversified. As with many things, the devil in index investing is in the details.

Australian Index Exposures

Take for example the most popular Australian stock index the S&P/ASX 200, this index is created using what’s called a market cap weighted index. This means that a stocks proportion of the index is determined by the market value of the company.

Therefore, the larger the company, the greater the greater share of the index it represents at any given time. The current top 5 holdings of the ASX/200 are (2):

1. BHP Group
2. Commonwealth Bank Australia
3. CSL Ltd
4. National Australia Bank Ltd
5. Westpac Banking Corp

A result of this index construction methodology is that profitable industries with many large public companies end up representing an oversized proportion of the index. For instance, the breakdown of the top 5 sectors in the S&P/ASX 200 is as follows (3):

• Financials 28.8%
• Materials 25.8%
• Healthcare 9.1%
• Consumer Discretionary 6.9%
• Real Estate 6.7%

As you can see, the Financials and Materials sectors dominate the index and make up over 50% of index’s total. Compare this with the US S&P 500, where Financials and Materials represent only 13.7% of the total index, and it becomes clear that the Australian share market, as represented by the ASX/S&P 200, may not present an ideally diversified investment exposure.

Building More Diversified Portfolios – Understanding the Ingredients

At Partnervest, we create portfolios comprised of multiple index and fund products based on a careful analysis of the underlying exposures within. By doing this, we are able to craft portfolios that have asset allocations that are diversified based on the logic of fundamental risk exposures and correlations, rather than just the whims of market pricing dynamics.

Our online platform is designed to make it easy for you to allocate your cash to a portfolio of carefully selected investment products designed to harness the benefits of diversification, and specified to target risk and volatility levels. In a world of rising uncertainty and fast-moving markets, having a partner that can help you invest your wealth quickly, easily, and intelligently can make all the difference.

To learn more about how you can start building a sound financial future, visit our website at partnervest.com.au.

IMPORTANT INFORMATION

You also need to maintain a balance of at least $2500 in your Cash Hub at all times.

All investments carry risk. Before deciding to invest, you should consider the following key risks:

• The value of investments will vary. You can lose money as well as make money.
• The level of returns will vary, and future returns will differ from past returns
• Returns are not guaranteed and investors may lose some or all of their money, and
• Laws change.

Important Information

Past performance is not an indicator of future returns. Issued by Partnervest, a division of Franklin Templeton Australia Limited (ABN 76 004 835 849, AFSL 240827).

Before making an investment decision you should read the relevant Product Disclosure Statement (PDS) carefully and you need to consider, with or without the assistance of a financial advisor, whether such an investment is appropriate in light of your particular investment needs, objectives and financial circumstances. The PDS is available and can be obtained by contacting Partnervest on 1800 679 541 or at www.partnervest.com.au.

The information in this presentation is of a general nature only and is not intended to be, and is not, a complete or definitive statement of the matters described in it. The information does not constitute specific investment advice and does not include recommendations on any particular securities. Franklin Templeton Australia Limited nor any of its related parties, guarantee the repayment of capital or performance of any of the Franklin Templeton trusts referred to in this document. Although statements of fact in this presentation have been obtained from and are based upon sources Franklin Templeton Australia Limited believe to be reliable, we do not guarantee their accuracy, and any such information may be incomplete or condensed. All opinions and estimates included in this communication constitute our judgement as of the date of this communication and are subject to change without notice.

(1) Source: The Financial Times – https://www.ft.com/content/a7e20d96-318c-11ea-9703-eea0cae3f0de
(2) Source: S&P Dow Jones Indices – https://www.spglobal.com/spdji/en/indices/equity/sp-asx-200/#data
(3) Source: S&P Dow Jones Indices – https://www.spglobal.com/spdji/en/indices/equity/sp-asx-200/#data