There has been a gradual shift in mentality on active management and portfolio construction in order to increase the return potential in Australian equity portfolios. Part of this has involved gravitating towards more unconstrained managers which typically run more concentrated, higher risk and higher active share portfolios. While we believe that this change is beneficial for net-of-fee return outcomes, it also comes with important portfolio construction implications.
Traditionally, portfolio construction of active Australian equity portfolios involved the use of relatively diversified, benchmark-aware investment strategies, typically managed within tight stock and sector constraints. In a market like Australia, which has high degrees of stock and sector concentration at the largecap end of the market, it is impossible for these managers to take meaningfully large deviations in positions in many stocks. Such constraints mean that investors tend to obtain restricted mid- and small-cap exposure via these strategies. Instead, for investors desiring a more meaningful mid- or small-cap exposure above the index weight, the traditional approach has generally required making a strategic decision on whether to hire mid- and small-cap specialists to sit alongside core managers.
Mid- and small-caps have historically represented a meaningful allocation of many investors’ portfolios, despite limited evidence to support the existence of a small-cap beta premium in the Australian market (Figure 1). That said, we have always seen merit in having a moderate overweight to mid- and small-cap stocks via active management from a total return perspective. This part of the market offers a number of benefits over a market-cap neutral portfolio, some of which include:
These considerations can create complexities for investment committees and risk adding to what is, in many cases, a heavy governance burden to select, manage and be accountable for such strategic exposures.
Download our PDF for more insights on better equity portfolios, and important portfolio construction implications.
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The mid- and small-cap dilemma in Australian equity portfolios | .6 MB |