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Issue Date: Wed 11-Apr-2018
Article Source: http://www.afr.com/personal-finance/shares/diversification-vital-in-a-changing-proper...

As the property market changes, diversifying your investment portfolio is vital

We Australians have an obsession with property. Whether this manifests in the dream of owning our own home or our appetite for property within our investment portfolios, it remains front and centre in the Australian psyche

We Australians have an obsession with property. Whether this manifests in the dream of owning our own home or our appetite for property within our investment portfolios, it remains front and centre in the Australian psyche.

Adding wind to these sails, the past 25 years has been a period of unprecedented economic expansion, with property prices supported by falling interest rates and increasing leverage.

At some point we know this wind will change – though if the past 10 years has taught us anything, it is that timing the end of market cycles is extremely difficult.

What are the implications of a slowing property market?

Five factors we have found to drive property investment are all now pointing to a slowdown in the property market. Joe Armao

While it is impossible to predict when this change will occur, diversification is an important principle to maintain.

To maintain a diversified portfolio, we need to understand the risks and areas of concentration toward a single or correlated theme.

Optimism bias

Australian investors tend to have a significant concentration toward property. Given the extended period of favourable conditions for property investors, there is an optimism bias baked into our psyche, which has played out in high levels of exposure to property across multiple layers of investments.

For example, the average exposure to property within default superannuation plans (MySuper) is about 12 per cent. This is a mix of direct property exposure, as well as listed property exposure within the Australian and global equities allocations.

Typical self-managed superannuation fund (SMSF) portfolios include a 15-20 per cent exposure to property.

To fully assess concentration risk, it's important to consider other related exposures such as the property lending by Australian banks which form a large proportion of their loan books.

The Australian sharemarket has a hefty allocation of 25 per cent to banks, compared with 9 per cent in the global equity market. Additionally, personal investment portfolios, defined as investments held outside of super and excluding the family home, contain over 40 per cent exposure to direct property.

This level of concentration within portfolios warrants a higher degree of caution by investors.

The perception of property as a safe asset often ignores the higher risk associated with holdings in a single property or even single sub-markets.

Price volatility

A study of price moves shows a two- to three-fold pick up in price volatility for individual capital cities when compared with the national average. Owning a single investment property doesn't give an investor exposure to the characteristics of the whole market.

When it comes to downturns, while it is difficult to determine both the timing and the severity, we shouldn't turn a blind eye to the potential risks present in the portfolio which can exaggerate market conditions.

Five factors we have found to drive property investment are all now pointing to a slowdown in the property market. These include:

Low affordability due to high household debt.
Increasing supply.
High prices.
Tightening credit conditions.
Softening rental income growth.

While these factors may not signal the timing of a downturn, they signal the need for caution and an investigation of the concentration risk that may exist in your portfolio.

How did we get into this position?

Twenty five years of uninterrupted economic growth, steady price appreciation, falling interest rates and tax incentives in the form of negative gearing have all been supportive of investor demand in property.

More broadly, another potential factor contributing to the high levels of concentration in the form of home equity bias has been Australia's dividend imputation system.

If current levels of concentration risk are maintained, it may come at a cost, with the Australian economy starting to diverge. Record high household debt is placing consumers under considerable pressure, and a fading effect from the construction boom places Australia in a vulnerable position.

Following a set of sound principles will help guard against concentration risks, and ensure your portfolio is positioned appropriately to withstand the sometimes stormy seas of the sharemarket.

Define your goals and set asset allocation to deliver on them, maintain diversification by balancing risks and exercise discipline by sticking to your strategy and taking a long-term perspective.



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