Investors should consider small company stocks as a means to protect against concentration risk, according to Avoca Investment Management.
While investing in small companies is traditionally seen as more risky than investing in larger ones, Avoca Investment Management managing director John Campbell cautioned that the ASX 100’s heavy exposure to specific sectors, such as financials, poses other risks for investors to consider.
“Financials represent around 40 per cent of the ASX S&P 100 benchmark – providing a worrying level of concentration risk,” Mr Campbell said.
“Conversely, the composition of the S&P/ASX Small Ordinaries is much more balanced and aligned to the Australian economy.”
Mr Campbell noted that the ASX Small Ordinaries index has previously had a 48 per cent skew towards one individual sector, which caused “massive pain” to investors in 2010 and 2011 as the Chinese economy of the time began to slow.
“Since then, concentration risk has diminished in small caps but increased in large caps,” he said.
“Investors need to understand these risks and, in the case of large caps, understand that the glory days of setting and forgetting their portfolios with a huge bank exposure is unlikely to be a smart strategy for the next five years.”