According to DFA's insights, an excessive reliance on local markets leads to a narrow exposure concentrated in a limited number of sectors or companies. This approach can cause investors to miss out on the broader potential of international markets that are underrepresented in their local market.
The concentration risk in markets like Australia is significant due to the overwhelming dominance of a few major companies. Despite Australia hosting only about 2% of the global equity market, statistics show it is not unusual for investors to dedicate half of their equity holding domestically, forgoing the vast potential outside Australia and New Zealand.
The situation is even more concentrated in portfolios biased towards local markets such as New Zealand. There, only specific large national companies prevail, leaving a massive gap in the diversification possibilities available worldwide. To highlight this disparity, 18,000 companies trading beyond these shores represent roughly 98% of the world's $120 trillion equity market capitalisation.
- A 50% allocation to Australian stocks might mean significant exposure to merely five companies. This scale mirrors the cumulative weight of stocks from 46 international markets with over 15,500 companies, indicating lost potential in diversifying risks and seizing growth globally.
- Exploring global markets allows investors to diversify their return sources, compensating weaker domestic returns with stronger performances elsewhere.
The DFA emphasizes a diversified, global portfolio as a strategy to harness equities' returns worldwide. As per their research, broad international investment can help counteract regional market downturns, spreading risk across diverse sectors and economies.
This concept was evident in 2021: while Australian equities returned 16%, those in the UK and US soared by 26% and 35%, respectively. Similarly, the global bond market offers varied yields and forecasts, often differing across countries and currencies, further underlining the advantage of a borderless investment view.
Ultimately, adopting a global viewpoint offers investors chances at higher expected returns and portfolio diversity, potentially minimizing risks and smoothing volatility. The DFA remarks, "This isn’t guaranteed to produce strong returns every year, but it can deliver more reliable outcomes over time, helping investors stay on track toward achieving their long-term goals."
This insightful analysis was originally reported by Yasmine Raso for Dimensional Fund Advisors and highlights how significant wealth-building potential lies in the untapped global markets.
