How to gain diversification in concentrated markets
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    How to gain diversification in concentrated markets

    Russel Chesler, Director, Investments & Portfolio Strategy
    28 July 2020
    The Australian stock market is one of the most concentrated in the world with the top 10 stocks making up ~45% of the S&P/ASX 200. At a sector level it is even more concentrated.

    Most investors are familiar with the concept of diversification. We know that if we put all our eggs in one basket our returns will experience high volatility, but if we spread our investments across several different assets we’ll reduce the volatility of returns. In fact, diversification is such a key component of share investing that the Cambridge Dictionary even refers to the stock market in their definition of ‘diversify’: People are advised to diversify their investments in the stock market to reduce risk.

    So how do you improve diversification when investing in a highly concentrated sector?

    The answer is capping the weight to individual stocks.

    As an example, we can take a look at the A-REITs (listed real estate investment trusts) sector in Australia and compare the S&P/ASX 200 A-REIT Index which is weighted by market cap and the MVIS Australia A-REITs Index which caps individual stock weights at 10% on rebalance1.

    S&P/ASX 200 A-REIT Index

     

    MVIS Australia A-REITs Index

    Security Name

    Index Weight (%)

     

    Security Name

    Index Weight (%)

    Goodman Group

    26.17%

     

    Goodman Group

    11.93%

    Scentre Group

    10.87%

     

    GPT Group

    10.26%

    Dexus

    9.97%

     

    Dexus

    10.09%

    Mirvac Group

    8.43%

     

    Mirvac Group

    9.35%

    GPT Group

    8.20%

     

    Stockland

    9.02%

    Stockland

    7.72%

     

    Scentre Group

    8.75%

    Vicinity Centres

    5.33%

     

    Vicinity Centres

    8.54%

    Charter Hall Group

    4.63%

     

    Charter Hall Group

    8.38%

    SCA Property Group

    2.35%

     

    BWP Trust

    4.79%

    BWP Trust

    1.97%

     

    SCA Property Group

    4.78%

    Charter Hall Long Wale REIT

    1.95%

     

    Charter Hall Long Wale REIT

    4.63%

    Waypoint REIT

    1.92%

     

    Cromwell Property Group

    3.55%

    National Storage REIT

    1.89%

     

    National Storage REIT

    3.47%

    Cromwell Property Group

    1.67%

     

    Abacus Property Group

    2.44%

    Charter Hall Retail

    1.58%

         

    Ingenia Communities

    1.25%

         

    Centuria Industrial

    1.10%

         

    Unibail-Rodamco-Westfield

    1.05%

         

    Abacus Property Group

    0.98%

         

    Growthpoint Properties

    0.98%

         


    We have calculated the Herfindahl index for both indices. The Herfindahl index is a commonly used measure of market concentration. The lower the Herfindahl index, the better as a lower index number signifies less concentration and greater diversification.



    As you can see above, the MVIS Australia A-REITs Index has a lower Herfindahl index than the S&P/ASX 200 A-REIT Index even though it only includes 14 A-REITs compared to 20 in the market cap weighted S&P/ASX 200 A-REIT Index. It has a lower Herfindahl index and less concentration and greater diversification as a result of the stock weightings being capped at 10%.

    Capping of stock weights helps reduce concentration risk and improve diversification in highly concentrated markets and sub-sectors.



    1. Indexes are rebalanced at regular intervals to update constituents at which time weightings are also reset in accordance with the index rules. The MVIS Australia A-REITs Index is rebalanced quarterly. Outside those dates market movements result in weighting changes, which may include above the cap.
    IMPORTANT NOTICE:
    This information is issued by VanEck Investments Limited ABN 22 146 596 116 AFSL 416755 (‘VanEck’) as responsible entity and issuer of the VanEck Vectors Australian Property ETF and other VanEck exchanges traded funds on ASX. This information contains general advice only about financial products and is not personal financial advice. It does not take into account any person’s individual objectives, financial situation or needs. Before making an investment decision, you should read the PDS and with the assistance of a financial adviser consider if it is appropriate for your circumstances. PDSs are available at www.vaneck.com.au or by calling 1300 68 38 37. The funds are subject to investment risk, including possible loss of capital invested.

    The PDS details the key risks. Past performance is not a reliable indicator of future performance. No member of the VanEck group of companies gives any guarantee or assurance as to the repayment of capital, the payment of income, the performance, or any particular rate of return from any fund.

    MVIS Australia A-REITs Index (‘MVIS Index’) is the exclusive property of MV Index Solutions GmbH based in Frankfurt, Germany (‘MVIS’). MVIS is a related entity of VanEck. MVIS makes no representation regarding the advisability of investing in the Fund. MVIS has contracted with Solactive AG to maintain and calculate the MVIS Index. Solactive uses its best efforts to ensure that the MVIS Index is calculated correctly. Irrespective of its obligations towards MVIS, Solactive has no obligation to point out errors in the MVIS Index to third parties.