Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 82

Building more relevant Australian share portfolios

The Australian equity portfolio management industry is highly competitive. However, the portfolios it delivers can be under-diversified by security and sector, and key product offerings appear undifferentiated to all but the keenest observers. With the exception of some funds focussed on companies outside the largest 100 companies, most managers’ portfolios mirror the capitalisation-weighted S&P/ASX 200 index.

Is this a problem? After all, over the last two decades the returns from professionally-managed Australian share portfolios have been attractive. To the extent that there is a problem, it is fair to say a good deal of responsibility rests with clients and intermediaries rather than investment managers. In this industry products and services respond rapidly to well-articulated and consistent demand but the incentives clients set for managers is a key impediment to innovation.

Clients and their advisers define equity mandates in terms of the S&P/ASX 200 benchmark portfolio, and assess performance relative to the benchmark over short periods. Sometimes management contracts incorporate performance fees which specifically reference these benchmark returns. It is therefore entirely sensible for a manager to reflect their investment insights through a portfolio of securities whose weights are anchored to the security and sector weights of the benchmark.

The resulting portfolios become under-diversified because the benchmark itself is under-diversified. While the index incorporates around 200 securities, its eight largest names represent over half the benchmark capitalisation while two of the ten industry sectors – Financials and Materials - represent over 60% of its capitalisation. A manager who is not attracted to these particular segments of the market, but operates under a benchmark-focussed mandate, can feel constrained in terms of how aggressively they can represent these views in their portfolio. Where the manager would prefer to express a favourable view of these market segments, there is a risk that the portfolio becomes dangerously concentrated.

How might clients and intermediaries reframe mandates to better leverage managers’ investment insights? The starting point is to understand how an investor defines investment success. Is the benchmark index really so important to achieving the client’s goals? Here we consider ways to deliver superior benchmark-relative portfolios as well as identifying some increasingly important alternative goals.

Benchmark-relative approaches and expensive indexing

Super funds and large wealth managers typically conform to the institutional approach of delivering benchmark-focussed Australian equity portfolios to their members and clients. They believe, perhaps implicitly, that their own performance will be assessed relative to the benchmark index or relative to their benchmark-focussed peer group.

These portfolios are often created by allocating broad market mandates to several equity managers, each selected for their capacity to deliver returns in excess of the S&P/ASX 200 index. Given the concentrated nature of the benchmark this approach can be an inefficient and expensive way to capture and deliver the managers’ collective insight.

The source of the inefficiency is most apparent in the super funds’ overall exposure to the larger companies in the market. Rather than directly reflecting a manager’s optimism about a stock’s return prospects, the aggregate exposure to a large-cap company ends up reflecting the managers’ outlook for these stocks plus their different attitudes to benchmark-relative risk management.

In practice, super fund managers can end up trading between themselves in these larger names which is inefficient from a transaction cost, tax and management fee perspective. This is most evident in cases where a position taken by one manager largely offsets the position of another. This inefficiency leads to the somewhat unfair description of multi-manager portfolios as ‘expensive indexing’.

One simple approach to address this is to specify mandates that require managers to operate in market segments where their insights are likely to be most effective. For instance, the 20 largest companies are extensively researched by analysts yet coverage of mid-cap and small-cap names is more limited. A skilful manager who takes a position in these less researched stocks could earn a higher reward for risk.

A super fund that mandates most of its Australian equity managers to replicate the benchmark for the market’s top 20 stocks, while focussing on stock selection for the remainder of the universe, obtains several benefits:

  • Transaction costs, tax leakage and management costs will be reduced in this portfolio design.
  • While the level of return above benchmark may be modestly reduced, relative to the approach based on broad market benchmarks, the profile of the excess returns delivered should be far more stable.
  • Super funds that are genuinely concerned about benchmark concentration in Australian shares have the opportunity to adjust their overall share portfolio without disrupting their underlying managers preferred positioning.

Some SMSFs might be more attracted to managed funds where exposure to larger Australian companies has been excluded. These SMSFs might believe they are as well-placed as the professionals to build a portfolio of large cap stocks while acknowledging they lack the capability to research smaller companies.

Goal-based strategies

There are a growing number of investors who care more about the achievement of their own specific goals rather than sweating on a manager’s short-term performance relative to a benchmark. For these investors the benchmark index merely presents an opportune set of securities rather than a neutral portfolio or a performance hurdle.

Their focus is on the design and management of a portfolio of securities with suitable fundamental and technical characteristics to support their desired outcome. When compared to benchmark-focussed approaches, these tailored portfolios typically have higher exposures to mid- and small-cap stocks and less to the large-caps.

Three differentiated investment outcomes appear to resonate with clients:

  • the delivery of a sustainable income stream (Australian equity income strategies)
  • resilient growth in wealth (resilient equity strategies)
  • high, long-term compound growth in wealth (long-term, long only strategies).

The critical distinction between these goal-based strategies and the benchmark-focussed approach is that managers are responsible for the total risk and return characteristics of their portfolios rather than just excess return and tracking error to benchmark.

Summary

The vast majority of managed funds and mandates in Australian equities deliver broad market portfolios. The future is likely to be different with clients becoming more involved in specifying the segments in which their managers operate and the outcomes they require.

 

Jeff Rogers is Chief Investment Officer at ipac Securities, AMP Capital.

 

RELATED ARTICLES

Clime time: Why stocks beat bonds for income investors

Five personal checks on your financial health

How dot plots and tiny triangles shape our investments

banner

Most viewed in recent weeks

16 ASX stocks to buy and hold forever, updated

This time last year, I highlighted 16 ASX stocks that investors could own indefinitely. One year on, I look at whether there should be any changes to the list of stocks as well as which companies are worth buying now. 

2025-26 super thresholds – key changes and implications

The ABS recently released figures which are used to determine key superannuation rates and thresholds that will apply from 1 July 2025. This outlines the rates and thresholds that are changing and those that aren’t.  

Is Gen X ready for retirement?

With the arrival of the new year, the first members of ‘Generation X’ turned 60, marking the start of the MTV generation’s collective journey towards retirement. Are Gen Xers and our retirement system ready for the transition?

Why the $5.4 trillion wealth transfer is a generational tragedy

The intergenerational wealth transfer, largely driven by a housing boom, exacerbates economic inequality, stifles productivity, and impedes social mobility. Solutions lie in addressing the housing problem, not taxing wealth.

What Warren Buffett isn’t saying speaks volumes

Warren Buffett's annual shareholder letter has been fixture for avid investors for decades. In his latest letter, Buffett is reticent on many key topics, but his actions rather than words are sending clear signals to investors.

The 2025 Australian Federal election – implications for investors

With an election due by 17 May, we are effectively in campaign mode with the Government announcing numerous spending promises since January and the Coalition often matching them. Here's what the election means for investors.

Latest Updates

World's largest asset manager wants to revolutionise your portfolio

Larry Fink is one of the smartest people in the finance industry. In his latest shareholder letter, the Blackrock CEO outlines his quest to become the biggest player in private assets and upend investor portfolios.

Economy

Australia's economic report card heading into the polls

Our economy grew by a nominal rate of 7% per annum from 2017 to 2024, but it benefited from the largesse of fiscal and monetary policies, both of which are now fading. We need a new, credible economic growth agenda.

Preference votes matter

If the recent polls are anything to go by, we are headed for a hung parliament at the upcoming federal election. So more than ever, Australians need to give serious consideration to their preference votes.

SMSF strategies

Meg on SMSFs: Tips for the last member standing

It’s common for people as they age to seek more help in running their SMSF if their capacity declines. An alternate director may be a great solution for someone just planning for short-term help in the meantime.

Wilson Asset Management on markets and its new income fund

In this interview, Matthew Haupt from Wilson Asset Management discusses his outloook for the ASX, sectors such as REITs that he likes, and his firm's launch of a new income-oriented listed investment company.  

Planning

‘Life expectancy’ – and why I don’t like the expression

Life expectancy isn't just a number - it's a concept that changes with survival rates over time. This article breaks down how age, survival, and societal factors shape our understanding of life expectancy, especially post-Covid. 

The shine is back on gold, and gold miners

Gold mining stocks outperformed in 2024 and are expected to do well in 2025. At this point in the rally, it's worth considering what has driven gold prices higher and why miners could still have some catching up to do.

Sponsors

Alliances

© 2025 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.