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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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