Are you under the illusion that your portfolio is diversified?
Australians feel safe because of what has worked in the past.
This article originally appeared in the Australian Financial Review as an op-ed.
Domestic concentration has historically been rewarded in Australia. Over the past three decades, property, banks and resources have delivered strong results for individuals and the country as a whole.
Investors have bought into the narrative that local assets are both profitable and reliable.
This apparent stability of portfolios hides the underlying concentration risk. This risk may become painfully clear when economic conditions shift.
When seemingly disparate assets depend on the same drivers such as credit expansion and commodity demand, they may move together during downturns, as we have seen before with our American cousins.
The macroeconomics aren’t abstract
As in the Federal Budget, the national debate settles around familiar fault lines – high levels of debt, housing affordability and structural imbalances, weak productivity growth and an overreliance on China.
These are typically framed as policy challenges, but these same issues are impacting investor portfolios, The same exposures that policymakers are concerned with are embedded in household balance sheets.
Many investors think they are diversified, but instead their financial outcomes are tied to a narrow set of economic drivers. Source: In order of percentages: Australian Institute of Health and Welfare (2022), Metropole (2025), Finder (2021), ASFA (2025), ASX (2023).
Australians are overweight housing, have high levels of leverage through mortgages, a heavy allocation to Australian equities with an indirect reliance on Chinese demand. Australians are making the same macro bets and doubling down.
Diversification by structure is not diversification by exposure
A typical high-income household balance sheet in Australia is dominated by three components:
- Residential property
- Domestic equities
- Superannuation
However, when viewed through the lens of economic exposure rather than asset labels, the overlap becomes clear.
The Australian equity market is highly concentrated. Financials and resources make up a significant portion of the index. The composition of the largest Australian Shares ETF – Vanguard Australian Shares Index ETF (VAS), shows this clearly.
Source: Morningstar, Vanguard Australian Shares Index ETF holdings vs Morningstar Category average.
An investor in Vanguard Australian Shares has over 30% is in Financial Services, and around 25% in Basic Materials. 45% of assets are in the top ten holdings, with 17% in the top two holdings – Commonwealth Bank of Australia (CBA) and BHP Group Ltd (BHP).
Residential property, meanwhile, is deeply tied to household income growth, credit availability and employment stability. These are the same factors that influence bank profitability and their ability to sustain dividends.
Adding to this, these factors are indirectly connected to Australia’s external growth engine – demand for commodities. Over the past two decades, that demand has been overwhelmingly driven by China.
The reinforced bet on banks and commodities
Between 2000 and 2020, China’s share of Australia’s exports grew dramatically. Iron ore alone became a cornerstone of our national prosperity, at times accounting for a substantial share of export income. Chinese demand for iron ore supported national income growth, fiscal stability, wage growth and employment.
Domestic wealth creation became intertwined with these flows as rising national income support housing values. Housing supported credit growth with the majority of bank earnings coming from mortgages. Banks dominate local equity markets.
An investor who owns property and Aussie equities is relying on the same driver - sustained demand for Australian resources.
The financial system amplifies this alignment.
The housing market and banking sector are closely interlinked. Mortgage lending represents a large share of bank balance sheets, and access to credit underpins housing demand. Strong housing markets support bank earnings, in turn supporting credit availability, which supports housing demand.
For investors, this means that holding both property and Australian banks provides less diversification than one might think.
Many Australians consider the inevitability of the continued strength of the Australian housing market. The variables on which it is built on, including the newly proposed changes to taxation, could trigger the weakening of the market. The impact may extend beyond property values into bank profitability and equity market performance.
A severe example is the Global Financial Crisis. Many investors believed they were properly diversified across asset classes through equities and real estate. However, both were ultimately tied to housing credit conditions and general consumer sentiment.
Australia’s relative performance during this period is not insurance for future market shocks. Coming out of this relatively unscathed was due to strong external demand and policy support that sustained national income. It’s not evidence that domestic portfolios were inherently diversified.
The danger is not that these drivers fall overnight. It’s that they weaken together. For this reason, investors need to be mindful about their future projections for portfolio outcomes without considering this risk.
Reframing diversification
Diversification has generally been portrayed as a pie chart of assets. Adding additional asset classes is supposed to provide diversification.
However, as this analysis highlights, it is worth taking a step back and looking at what drives the performance of these assets. Two assets can belong to different categories but respond to the same forces.
I work in financial services, and my skills and experience are aligned to the industry. With over 30 years to go until I access my superannuation, my assets are heavily concentrated in equity markets. Like many in the industry, my compensation includes a share plan that further concentrates my future outcomes with my company. I have a mortgage. The objective of this journey of self-awareness is not to abandon Australian property or equities (or my job). Recognising these overlapping exposures provides the opportunity to better insure against these risks. The goal is not to eliminate volatility but to acknowledge hidden concentration, understand how it will likely behave through market cycles, and reduce concentration where needed.
Part of this is recognising what you can do to protect yourself if these underlying drivers go pear-shaped. For me, that is ensuring that I have adequate cash reserves to ride out any volatility and ensuring that I have a proper understanding of how my exposures connect to what I am trying to achieve. This confidence staves off poor behaviour during volatility. It sounds like simple advice, but many do not practice this.
Morningstar’s behavioural research team has found that most of us, including high income earners, do not have enough cash to provide peace of mind, let alone protect against the volatility from a change to an underlying driver of our national prosperity. In the study, 30% of respondents with the highest investable asset base (more than $349,000 USD), did not have enough to protect themselves. This caused undue anxiety and stress, for those who could afford to lessen it but were not structured in that way.
Being adequately self-insured is a large part of my strategy. Awareness is the second part.
Further Morningstar research with our Mind the Gap study shows that we are our own worst enemy. The latest results show that on average, investors reduce their returns by 1.2% p.a due to poor behaviour. Part of this is attempting tactical allocations based on latest performance data. The other is cost.
On a $100,000 portfolio with $1,000 additional investments each month*, this poor behaviour results in $163,619 less after 20 years. It is not an insignificant amount.
Figure: Impact of poor behaviour on portfolio outcomes
I can’t eliminate poor behaviour but I can try to prevent it by understanding how my investments will behave through market cycles. A large part of this is going through the exercise of understanding my exposure. This allows me to rationalise market volatility and connect it back to what my portfolio is trying to achieve. All investors can benefit from this exercise.
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