As previously stated, balanced funds direct nearly 35 per cent of their total assets towards Australian shares. What is concerning, is what this means at a stock level. A current ASX 200 index weight of 14.0 per cent towards BHP would suggest that this one stock has a 4.6 per cent total allocation within the average diversified balanced fund. Compared to the larger and deeper international market, this would suggest that most Australian funds have almost as large an allocation to BHP as they do to a combined index weight in UK and Japanese equities. Holding an index weight in just two stocks, BHP and Rio, would match the total index weight held within the whole continental European equity market. Assuming an index weight in Fortescue Metals Group (FMG), this position would deliver a larger total allocation than held in ALL of China.

Whereas there are plenty of other examples of large cap bias and influences, what makes this interesting is that much of this bias stems from a near unprecedented five-year, triple-digit return from one sector – resources.

Why we raise this stems more from highlighting a potential mismatch in how we define balanced fund objectives from a CPI plus ‘x’ per cent or years of positive returns, versus a more static ‘let it ride’ 60/40 allocation. As an asset class’ constituency changes, would it not be equally correct to reconsider the risk/reward implications from the changed asset? As detailed above, there has been a complete role reversal in the past eight years as to the constituency within Australian equities, yet there have been modest shifts in allocations. So far, this inactivity has delivered net positive results – but is it reasonable to assume these benefits will continue indefinitely? And has the shift towards a more dominant exposure in what has historically been a volatile sector altered the risk/reward definitions for diversified funds?

Risk management is not about altering your decisions, but identifying where the bets are being taken and how this could potentially alter the return profile. Most diversified funds have more money in two stocks than they do in the whole continental European equity market. Most have more money allocated towards resources stocks than held in the whole US equity market. And assuming the Australian resource boom has a lot to thank China for, an index holding in Fortescue Mining Group equates to a larger total exposure than the whole of China, and off a free float of only 47 per cent!