Many market participants have a “home bias,” typically having larger exposures to domestic securities than would be determined by their representation in the global opportunity set. Australia is no exception: compared to Australia’s 2% weight in the S&P Global BMI, Australian investors allocated an estimated 49% of their total equity allocation to domestic stocks at the end of 2022.1
Exhibit 1 shows that Australia’s home bias—as measured by the difference between investors’ total domestic equity exposure and the country’s weight in the S&P Global BMI—is larger than several of its developed market peers, such as Canada, Japan and the U.K.
Such home bias means that investors have less exposure to the U.S. equity market, which makes up nearly 60% of the S&P Global BMI. The S&P Composite 1500® represents the investable portion of the U.S. equity market (~90%) by combining the large-cap S&P 500®, S&P MidCap 400® and the S&P SmallCap 600® and leaving out less liquid and lower quality stocks.
The U.S. is home to well-known global mega-cap names such as Apple and Microsoft, which may help to balance Australia’s overweight to Financials and Materials. Exhibit 2 shows that combining the U.S. and Australia’s equity benchmarks may help alleviate the domestic sector biases. Compared to the S&P Global BMI, the Australian bellwether underweights Information Technology by 18%, with I.T. being the S&P/ASX 200’s second-smallest sector, at 2%.
Potential diversification benefits could also have come in the form of improved risk/return profile. Exhibit 3 highlights that the S&P 500 outperformed the S&P/ASX 200 by 2% annualized since Dec. 30, 1994, in local currency and U.S. dollar terms. This makes the long-run outperformance of the S&P 400® and S&P 600® even more impressive; the non-perfect correlations of these indices versus the S&P 500 (shown in Exhibit 4) also means there is an opportunity for investors to diversify within their U.S. equity exposure as well to gain access to the unique characteristics of U.S. mid- and small-cap indices.
Exhibit 2 which shows that differences in sector composition may help explain the non-perfect correlation between the S&P/ASX 200 to our U.S. core equity indices, which ranges from 0.44-0.52 when looking at monthly returns in AUD terms, as illustrated in Exhibit 4. This moderate correlation suggests that combining the two sets of indices may lead to better risk-adjusted return than either one in isolation.
In Exhibit 5, we take the blue-chip benchmarks of both the U.S. and Australia and create hypothetical combinations of the S&P 500 and the S&P/ASX 200. We can see that adding the S&P 500 to the S&P/ASX 200 has historically improved return per unit of risk (risk-adjusted return) across all points on the efficient frontier over exposure to the S&P/ASX 200 alone.
While there are several reasons why Australian market participants may choose to have a home bias, in the past, U.S. equities helped investors diversify from sectoral home biases and historically improved domestic returns.
1 Thinking Ahead Institute, “GPAS 2023 Pensions Survey,” 2023.
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