The ASX Trap: Why and How To Diversify Your SMSF Portfolio

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The ASX Trap: Why and How To Diversify Your SMSF Portfolio

Authored by Global X ETFs

Westpac. BHP. Woodside Energy. CBA. Do these companies sound familiar? Well according to BGL data, chances are you may hold most if not all of them in your Self Managed Super Fund (SMSF).1

Australians are big believers in “investing in what you know”, so it makes sense that in the financial and resources dominated ASX, the six most popular stocks held by Australian SMSFs are the big four banks, BHP, and Woodside Energy2. But simply investing in what you know may not be the best strategy for your portfolio – the intense sector concentration of the typical Australian portfolio can actually negatively impact overall performance. So, how can SMSF investors navigate this issue?

Looking Out for Sector Concentration

What is diversification? Is it simply holding a selection of different stocks, or should it be something more?

One of the most important ways an investor can diversify their investments is sector and industry diversification. When building a portfolio, investors should be wary of the potential overlap of their stock picks. This is because companies of the same industry and sector, especially established large-cap stocks, tend to move in tandem with one another (barring any company specific events) as well as the industry as a whole.

Take for example the Commonwealth Bank of Australia (CBA), one of the most popular holdings in Australian SMSFs. As we can see in the table below, having taken ETFs out of the picture, the top three most correlated stocks to CBA are, in order: NAB, ANZ, and Westpac.

Evidently, it can be detrimental to investors to have a high concentration of holdings in the same sectors.

To Include or Exclude – That Is The Question

An obvious choice for investors who are looking to avoid sector and industry risk may be to purchase a low-cost ASX 200 index fund as it covers the entirety of Australia’s top performers, but this solution may not be as effective as it seems.

Did you know that financials (including Real Estate Investment Trusts, also known as REITs) and materials sectors make up more than 55% of the ASX 200 index’s total weight?3 This means that when you invest in broad ETFs which track the ASX 200 or 300, you may not actually be diversifying your portfolio because these funds also have a high concentration of financials and materials, which you are likely already holding. Hence, investing in the ASX 200 or 300 doubles down on your sector concentration, further reducing the effectiveness of its diversification.

A way to avoid this duplication, could be a low-cost index fund which makes exclusions in sectors most likely to be overweight – specifically the big banks and miners such as the Global X Australia ex Financials and Resources ETF (OZXX). OZXX is an ETF offering that removes financial and material sector skews from the ASX. Tellingly, when exploring the top holdings of OZXX, one will find that seven of the top 10 ASX 200 companies are missing.

By removing these heavy weighting equities, OZXX aims to help investors place a greater emphasis on sectors which are less prevalent in the ASX 200. OZXX is also a powerful portfolio completion tool in the case that your SMSF portfolio already holds bank and mining stocks, allowing you to freely express your degree of conviction by adjusting your exposure to the financial and materials sectors with how much OZXX you hold.

A Case for Both

There’s no denying that index funds tracking the ASX 200 play an important role in the Australian SMSF landscape. They allow investors to efficiently capture the entirety of Australia’s economy and have even historically outperformed the majority of active managers.4

However, for investors looking to take more control of their portfolio allocation, and for any SMSF investors that have already invested in individual shares, a fund like OZXX may be a way to provide sector diversification while maintaining the ability to hold the blue-chip stocks that many investors love.

  3. S&P Global. Data as of 31 March 2023.
  4. Most authoritative report is from S&P Global’s Spiva Scorecard.

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