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Reducing the home bias within portfolios and using index-agnostic managers are the most effective ways of dealing with excessive concentration to stocks in small markets, according to MLC. Speaking at the 2009 Biennial Convention of the Institute of Actuaries of Australia in Sydney late last month, Chris Condon, chief investment officer at MLC, listed eight ways for super funds to ameliorate “idiosyncratic risk” within their investment portfolios.

Top of the list was reducing the allocation to domestic equities; however he noted that the reasons for the home bias, such as not wanting to take on peer risk, and the tax concessions for domestic investors in Australian shares, will often trump the desire to reduce the bias. Condon said BHP and Rio accounted for 16 per cent of the ASX200 in May 2008, highlighting the risk for super funds in having too much of a bias towards the Australian market.

Using index-agnostic managers was the second most effective way of managing idiosyncratic risk, Condon noted, but super funds should “beware of lip service and look for behaviours rather than statements”. As a rule of thumb, super funds should ensure that 95 per cent of the time, the total portfolio holds not more than 3 per cent in any one stock as a result of the independent actions of investment managers, he said.

Other options for super funds looking to manage excessive concentration to stocks within their Australian equities portfolios include: living with it; imposing maximum absolute limits in mandates; improving manager diversification; managing the maximum individual concentration at a total portfolio level through tools such as an overlay; using capitalisation-capped indices and using non-capitalisation weighted indices.


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