The share price of the big banks has run hard over the past 18 months, as many investors have been chasing dividend yield. As banks make up more than 30% of the Australian share index, many investors will be highly exposed to the sector. We took a look at the banking sector to identify whether these exposures pose a risk, and what an investor can do to improve diversification within their portfolios.
The outlook for banks
We believe that banks look fully priced for a rising market. The key weakness of the Australian banking system is a low level of deposits relative to loans. To cure this, banks are ‘overpaying’ for deposits, and it’s our view that this isn’t going to change any time soon. Indeed, this is a key reason why mortgage rates are higher relative to the Reserve Bank of Australia cash rate than recent historical experiences.
With ongoing regulatory change, and a high starting point, this means that, net interest margins and future return on equity may not be as good as they have been. (Net interest margins measure the difference between interest income generated by banks and the amount of interest paid out to their lenders such as through deposits.) As such, we think investors should prepare for a period of lower return on equity from bank stocks.
How exposed are you to bank stocks?
With more than 30% of the Australian share index made up of the ‘Big 4’ banks, it’s important that investors take steps to address this concentration of risk.
We took a look at the average super fund’s exposure to the sector as well as the average SMSF investor. While it’s hard to get exact data regarding SMSF investors’ exposure, we made the assumption that their Australian share holdings were invested in very large Australian listed companies, and mimicked the ASX20 Index. Using this approach, when it comes to investments in bank stocks, the average SMSF investor holds more than double the risk in their portfolios than that of the average super fund. And interestingly, it’s not just the banking sector that SMSF investors could have high exposure to. Their portfolios may also have a greater degree of concentration risk around Mining, Property Trusts, as well as Staples and Telecommunications sectors compared to the average super fund.
What should investors do about this?
Clearly, it’s important that investors take steps to manage any risks around high concentration. There are a number of ways exposure can be reduced:
One way is to consider investing against global benchmarks where there is less concentration risk by sector.
Another tactic is to give greater discretion to active managers who avoid ‘hugging’ the benchmark and invest only into stocks where they have high conviction on future returns.
Further, goals based funds also tend to have significantly less sector risk, given their more holistic risk management approach, and, in some cases, active tail risk management.
Important note: While every care has been taken in the preparation of this information, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) makes no representation or warranty as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This information has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. Certain information in this website has been obtained from sources that we consider to be reliable and is based on present circumstances, market conditions and beliefs. We have not independently verified this information and cannot assure you that it is accurate or complete.