Ludovic Theau from Australian Ethical speaks to Laurence Parker-Brown from The Inside Network on what has changed across this investment theme in the last few years. The Inside Adviser
The average financial adviser is older and brings in more revenue than they did a year ago, but that hasn’t translated into a fatter salary according to data from Adviser Ratings.
Concentration risk and the scourge of lazy portfolios
Concentration risk is the topic du jour in financial markets at the moment. Asset managers and consultants alike are quick to highlight the growing concentration of both returns and capital into just a few names.
The catchy monikers and initialisms for these groups have become as ubiquitous as the companies themselves. We all know the Magnificent Seven in the US (Amazon, Apple, Alphabet, Microsoft, Meta Platforms, Nvidia, and Tesla), the GRANOLAS in Europe (GlaxoSmithKline, Roche, ASML, Nestlé, Novartis, Novo Nordisk, L’Oréal, LVMH, AstraZeneca, SAP and Sanofi), and even our very own ‘Humdrum Eight’ in Australia (Four banks, two mining companies, CSL and Wesfarmers).
Despite the hype, however, neither Australia or the US are among the most concentrated markets in the world, with the likes of Germany, the United Kingdom and France holding significantly higher levels of concentration.
That aside, there is a broader theme emerging from the world of financial advice, that of the ‘lazy portfolio’.
For all the advancement in technology and increased investment knowledge across this country in the last few decades, it’s hard to suggest that individual portfolio construction for the masses has evolved significantly.
The tailwind of falling bond yields has supported nearly every asset out there, to the point that growth stocks have outperformed value stocks for what feels like an eternity. This seems to have led to a level of complacency within portfolio construction, and a lack of appreciation for some of the ‘uncompensated’ risks that lie within portfolios.
Resilience is central to the way portfolios are constructed at both a high-level asset allocation level and in the construction of each individual asset class sleeve. The constant consideration of new investments and how they add to diversification is important, but I’d suggest the recent increase in concentration risk across the globe should serve as a reminder to ‘make our own bed’ first.
One of the most interesting themes to emerge when constructing client portfolios is the significant spread of returns. The difference between the average, worst and best return is far wider than most clients would appreciate.
So, what’s a lazy portfolio?
A lazy portfolio is one that is concentrated not just in too few holdings, but also in the winners of yesterday. It’s not uncommon to see portfolios holding three near identical growth-oriented global share strategies, side by side, despite a significant amount of overlap. Equally common are retiree portfolios that invest solely in Australian shares, giving no consideration to global shares, fixed interest investments or infrastructure.
But diversification isn’t a cure-all for a lazy portfolio, because a lazy portfolio can also be overdiversified. Combining too many different strategies, ETFs, managed funds or shares into one portfolio can ultimately lead to an index-like return at an actively managed cost.
Lazy portfolios are those that are only updated once per year, where asset allocation is ham-fisted and treated as an irregular afterthought. These portfolios are often characterised by lumps of cash on the sidelines as dividends and distributions come in and don’t get reallocated. Shifts in market sentiment necessitate a considered, regular, structured approach to asset allocation.
Position sizing is among the most important, but forgotten aspects of portfolio construction, particularly when direct shares are involved. What level should direct shareholdings be held at versus a managed fund or ETFs? Is a core/satellite portfolio structure appropriate? What role do the growing range of thematic and niche ETFs have to play in a diversified portfolio?
Maybe the most concerning trend is the aversion from a product type, like an ETF or fund, solely for personal reasons, all but ruling out an entire menu of investment options. Worth noting: the passive vs. active debate is redundant, with both clearly having a role to play within portfolios.
Advisers need to remain aware and open to not only new additions to portfolios, but ensuring those portfolios reflect the evolving nature of both markets and client expectations.
