Experts choice: Australian banks and the property market

Analysts at Bank of America, who the Chanticleer cited in its short Aussie banks article, are not the only ones predicting pressure on Australia’s property market. Each investment bank and brokerage house has a view.

Consistent themes across many reports are:

• Home prices are expected to continue to fall in Australia,
• Any downturn in housing possesses downside risk to the Australian economy, and
• Central banks, including the RBA, are unlikely to pivot from their current hiking cycle because of weaker housing markets.

For years Australian banks have been able to grow their mortgage books as new home buyers looked to take advantage of record low rates. It now looks as though growth in new mortgages will slow. In addition, a fall in property prices is likely to put pressure on non-performing loans. 

Most Australian portfolios linked to the S&P/ASX 200 Index are likely to have an exposure to banks around 18% because of their size.

The reason the S&P/ASX 200 Index has such as large allocation to Australian banks is because it is a market capitalisation index. A market capitalisation index uses the size of a company for inclusion and its representation in that index relates to its size. Therefore, in a market capitalisation index, the larger companies have bigger weights. This means Australian portfolios linked to this index have significant exposure to big banks.

A sizeable allocation makes sense if you are confident the sector will do well, but if you are not, it may not be prudent risk management.

The equal weight index that the VanEck Australian Equal Weight ETF (MVW) tracks is a smart beta index that equally weights the largest and most liquid stocks on the ASX at each rebalance. Because of this, at last rebalance, no company was more than 1.17%. MVW’s exposure to the big four banks at that time was only 4.68% (as at 31 August 2022 it was 4.69%).

Taking an equally weighted approach has been proven to produce outperformance over the long-term compared to a benchmark market capitalisation approach as well as providing diversification benefits.

So, let’s walk through the difference between MVW and the S&P/ASX 200.

MVW vs S&P/ASX 200 - Performance

Equal weight investing has served Australian investors. At the end of August 2022, since its inception on ASX in 2014, MVW has outperformed the S&P/ASX 200 by 1.91% p.a.

Chart 1: Cumulative performance since MVW inception date to 31 August 2022

Table 1: Trailing performance to 31 August 2022

* MVW Inception date is 4 March 2014 a copy of the factsheet is here.

Chart 1 and Table 1 source: Morningstar Direct, VanEck as at 31 August 2022. The chart and table above show past performance of MVW and of the S&P/ASX 200. You cannot invest directly in an index. Results are calculated to the last business day of the month and assume immediate reinvestment of distributions. MVW results are net of management fees and other costs incurred in the fund, but before brokerage fees and bid/ask spreads incurred when investors buy/sell on the ASX. Returns for periods longer than one year are annualised. Past performance is not a reliable indicator of future performance. The S&P/ASX 200 Index is shown for comparison purposes as it is the widely recognised benchmark used to measure the performance of the broad Australian equities market. It includes the 200 largest ASX-listed companies, weighted by market capitalisation. MVW’s index measures the performance of the largest and most liquid ASX-listed companies, weighted equally at rebalance. MVW’s index has fewer companies and different industry allocations than the S&P/ASX 200. Click here for more details.

MVW vs S&P/ASX 200 - Diversification

A way to measure diversification of a portfolio is to calculate its Herfindahl Index. This index is a broadly used technique to quantify concentration. When used inversely, this index measures diversification. As at the last rebalance in June 2022, the Herfindahl Index for the S&P/ASX 200 was 338. The equivalent measure for the index MVW tracks was 114. The MVW Index is therefore around a third as concentrated as the S&P/ASX 200. In other words, the MVW Index is roughly three times more diversified than the S&P/ASX 200.

MVW vs S&P/ASX 200 Index - Top 10 holdings

Below you can see the top 10 companies. The differences are stark – to see all the holdings in MVW and their weightings click here. 

Source: Left - FactSet, VanEck, as at 31 August 2022. Right - FactSet, VanEck, S&P, as at 31 August 2022.

The reason MVW’s holdings are not equal above is that it only rebalances back to equal weight each quarter. Noticeably Pilbara Minerals is now 1.75% of MVW. At June’s rebalance, it was 1.17%, like every other holding, but due to strong lithium prices its share price has gone up so it makes up a bigger part of MVW now. At the next quarterly rebalance, it will be pared and the portfolio holding will be equal. 

MVW vs S&P/ASX 200 Index - Sectors

MVW is currently underweight the financials’ sector by 9.56% compared to the S&P/ASX 200. Conversely, it is overweight industrials by 5.49% and information technology by 2.40%.

Chart 2: S&P/ASX 200 and MVW Index company weightings

Source: FactSet, 31 August 2022

What this means is that if there is another systematic banking issue, or commodities fall the impact on the S&P/ASX 200 is greater than in the MVW Index.

MVW vs S&P/ASX 200 Index - Style

When looking at portfolios it is important to determine what style e.g. value or growth and what size bias a portfolio holds e.g. giant, large, mid or small. Below we can see MVW’s. Importantly MVW holds large companies with a similar Morningstar style of core orientation relative to the S&P/ASX 200, which skews larger (giant) and more toward value.

Source: Morningstar Direct, as at 31 August 2022

MVW is being used by savvy investors as their core Australian equity portfolio, around which they add investment ideas. For example, should the economic environment become more favourable for banks, you can add to MVW by buying your preferred bank directly, as a satellite position. Alternatively, you could consider the VanEck Australian Banks ETF.

While each Australian equity approach, equal weight and market capitalisation, has its merit for portfolio inclusion, you should assess all the risks and consider your investment objectives.

Past performance is no guarantee of future performance. The above is not a recommendation. Please speak to your financial adviser or stock broker.

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