For some time now, I have been questioning why diversified portfolios in Australia typically hold almost half of their equity exposure in Australian shares and slightly more than half in international shares.
For example, AustralianSuper’s Balanced portfolio has approximately 25% allocated to Australian equities and around 34% to international equities, while UniSuper’s Growth portfolio holds roughly 31% in Australian equities and 42% in international equities. These examples go on and on when you look at diversified portfolios offered by industry super funds, ETF providers, and fund managers across Australia.
Over the past three decades, industry super funds have gradually reduced their “home bias” towards Australian equities in favour of international equities. However, despite this shift, the allocation to Australian equities remains relatively high.
Australia is such a small market
The Australian share market accounts for only around 2% of the global share market, which begs the question: why do most Australians still have about half of their equity exposure invested domestically? From a market-capitalisation perspective alone, this does not make much sense. It represents a very overweight and concentrated position when viewed on a global scale.
Interestingly, when you look at diversified share portfolios in other countries, they do not typically allocate anywhere near half of their equity exposure to their home market. Most are far closer to global market-capitalisation weightings.
Historical performance
Over the past 10 years, the Australian share market has underperformed the global share market by approximately 2% – 3% per annum, which is a meaningful gap. This underperformance is largely attributable to Australia’s limited exposure to fast-growing sectors such as technology, as well as significantly slower earnings growth compared to international peers.
However, if you extend the timeframe, the picture changes. Over the past 30 years, returns have been relatively similar, averaging around 8.0% – 8.5% per annum for both Australian and international equities.
Of course, it is very easy to look backwards and comment on past performance. With hindsight, we all have perfect 20/20 vision about how portfolios could have been constructed. Rather than focusing solely on historical returns, the more important question is whether there are structural benefits to the Australian share market that justify such a large domestic allocation for Australian investors.
The main factors often cited in favour of Australian equities are:
- Franking credits
- No currency risk
- Reduced portfolio volatility
- Higher dividend yields
- Different industry and sector exposure
- Comfort and home bias
Let’s explore each of these in more detail.
Franking credits
The tax impact of franking credits is certainly real and quantifiable. In many respects, they represent a form of a “risk-free alpha” for Australian investors. However, I believe their benefits are sometimes overstated.
Australian dividend yields are currently at their lowest level since Covid, sitting at approximately 3.5% for the ASX 200. Importantly, franking credits only apply to the income component of a portfolio’s total return, and their value varies depending on the tax rate of the investor.
For example, for shareholders on a 0% tax rate, such as a super account in pension/retirement phase, franking credits effectively add an additional 30% to dividend income. For shareholders on a 47% tax rate, the benefit is closer to 17%.
Based on a 3.5% dividend yield:
- A 0% tax-rate investor would receive an after-tax yield of approximately 4.55%
- A 47% tax-rate investor would receive an after-tax yield of approximately 4.09%
This means franking credits are effectively adding around 0.6%–1.0% per annum to returns. This is meaningful, but it is not transformational.
No currency risk
Investing in Australian shares using Australian dollars removes direct currency risk. This provides protection against domestic inflation and erosion of purchasing power within Australia.
Currency risk can, of course, be hedged when investing internationally, and most ETF providers offer hedged options. However, hedging introduces its own set of challenges.
If you hedge international shares, you are effectively betting that the Australian dollar will rise relative to other currencies. If you remain unhedged, you are betting that it will fall. In our experience, predicting currency movements is extremely difficult, arguably even harder than stock-picking, and most stock pickers already fail to outperform the market over time.
Over the past 25 years, the average returns from hedged and unhedged global equities have been broadly similar. The difference largely comes down to timing. Ultimately, currency exposure can either help or hurt portfolio returns depending on how exchange rates move.
Since the 2010s, the depreciation of the Australian dollar has supported unhedged strategies. Many investors have favoured unhedged exposures as the AUD tends to behave as a “risk-on” currency, while the USD often acts as a “risk-off” currency during periods of market stress.
However, with the AUD now hovering around US$0.70, interest-rate paths potentially diverging and Australia possibly pausing or hiking while the US is more likely to cut, further AUD appreciation cannot be ruled out. This could favour hedged strategies going forward.
Hedging can change how much of a fund’s return comes through as capital growth versus taxable distributions. Depending on the tax election the managed fund or ETF has made, hedging gains and losses may be brought to account each year (including unrealised movements), rather than only when positions are closed. The result is that distributions can be wiped out in some years or inflated in others, making them lumpy and often tax inefficient.
Portfolios that generate a higher proportion of returns from capital growth tend to outperform over time due to more favourable tax treatment and superior compounding. From this perspective, hedging-related income can be inefficient.
Here is how we think about hedging: we only focus on the entry point for new capital. If we are investing new money and the AUD is materially undervalued (for example, trading well below US$0.70), we will typically hedge the new investment; otherwise, we will leave it unhedged. But, over the long run, we do not think currency risk has a material impact on portfolio returns, and it is often overstated.
Reduced volatility
The Australian share market has historically been perceived as relatively stable and low volatility. However, this perception has changed in recent years.
Over the past 10 years, the standard deviation of Australian shares has been slightly higher than that of global shares, approximately 18% versus 17.5%. As shown in the chart below, Australian shares have experienced larger peaks and troughs in rolling one-year volatility compared to US and global markets.
Based on this data, the Australian share market has actually been more volatile than the global share market in recent years. This is somewhat surprising given Australia’s heavy exposure to banks and miners, which are often considered more defensive industries.
That said, because Australian and international shares are not perfectly correlated, combining them in a portfolio has been shown to slightly reduce overall volatility . This diversification benefit is one reason many fund managers prefer spreading equity exposure across regions.
While volatility is important, particularly for investors approaching retirement, minor short-term volatility differences should matter less for well-informed long-term investors. For those able to tolerate market fluctuations, the primary focus should be to maximise long-term after-tax returns, even if that means accepting slightly higher volatility along the way.
Higher dividend yields
The Australian share market has long been known for its relatively high dividend yields. As noted earlier, the ASX 200 currently yields around 3.5%, which is below its long-term average of approximately 4.5%. By comparison, the MSCI World ex-Australia index yields closer to 1.5%.
Historically, roughly half of total Australian share market returns have come from dividends. With dividend yields now compressed, the Australian market will need to generate stronger capital growth to maintain historical returns.
Under current economic conditions and given the structure of the Australian market, this may prove challenging. Australian banks delivered strong returns in 2024 (up approximately 31%), while miners had a strong 2025 (up around 41%). Looking ahead, it is difficult to identify where outsized returns will come from in 2026 to drive above-average capital growth.
We do acknowledge that higher income means we need less capital growth to achieve a benchmark return. However, for most long-term investors in the accumulation phase, receiving a greater proportion of returns as income is not ideal from a tax perspective. Income is taxed annually, often at higher marginal rates, whereas capital growth is taxed only when realised, if at all.
This tax drag reduces the compounding effect of returns over time. Investors focused on building wealth are generally better served by portfolios tilted towards capital growth rather than income. From this perspective, Australia’s high dividend yield can actually be a disadvantage for wealth accumulators.
Different industry and sector exposure
Australian banks and miners (financials and materials) make up more than 50% of the Australian share market. In contrast, the global share market is dominated by technology (around 24%), followed by financials, healthcare, industrials, and consumer discretionary sectors, each comprising roughly 11%–15%.
Global equities offer broader diversification across both industries and individual companies.
It could be argued that Australian shares provide diversification within a portfolio due to their unique sector composition. However, similar diversification benefits can also be achieved through exposure to other regions such as the UK, Europe, Japan, or emerging markets.
In an era defined by technological advancement, it is reasonable to question whether portfolios should have their largest sector exposure to the industry experiencing the strongest structural growth, namely technology.
Comfort and home bias
Australians often believe they have a better understanding of domestic companies. We all know someone who works at BHP or CBA, and these companies feature prominently in the media.
While familiarity may increase comfort, it does not necessarily translate into superior investment outcomes. Most investors do not possess enough insight to consistently select individual Australian stocks that outperform the market, and neither do most professional fund managers.
There is a clear behavioural home bias that is not grounded in evidence-based decision-making. Removing emotion and familiarity from the equation and allowing data to guide portfolio construction is far more likely to lead to better long-term outcomes.
Our conclusion
Australian equity exposure has been declining gradually in diversified portfolios over recent decades. Franking credits provide a genuine, risk-free benefit for Australian investors, and investing domestically removes direct currency risk. However, currency exposure can just as easily enhance returns when exchange rates move favourably.
The Australian share market has become more volatile than global markets over the past 5–10 years, although overall portfolio volatility can be reduced by spreading exposure across both Australian and international equities.
Australia remains a concentrated market with limited sector and company diversification. Its lack of exposure to high-growth sectors has contributed to weaker earnings growth and relative underperformance over the past two decades.
It would be unfair to say we are against investing in the Australian market, or even taking an overweight position. Like any market, it comes down to our assessment of likely medium to long-term returns. If we thought the Australian market was cheap (which we currently do not), we would be comfortable being overweight.
Ultimately, investors need to be clear about what they want from their portfolios. Investors in retirement who prioritise income may prefer a higher allocation to Australian shares. Conversely, high-income earning investors in the accumulation phase, focused on long-term after-tax compounding, may be better served by a greater allocation to global equities.
To be clear, we are not suggesting people abandon existing Australian market exposure, particularly where doing so would trigger significant CGT. The point of this blog is to encourage investors to think more critically about where they direct future investment dollars.
