Exposure compression: Why institutional portfolios move in sync, when they shouldn’t

Despite aiming to deliver “diversified” results, most balanced portfolios pivot around the same risk levers and dominant names. It means exposure compression, benchmark design and regulatory benchmarking concentrate risk into predictable choke points – the MAG-8, Australian banks and US dollar – which passive investing reinforces.

Diversification is often promoted as a shield against market shocks. In practice, most superannuation and institutional portfolios today are shaped by dominance risk and compressed exposures. Dominance risk stems from a few outsized stocks or issuers across asset classes. Compressed exposures mean risk is concentrated in a narrow set of macro levers – not spread across independent drivers.

Eight companies now dominate global equities: Apple, Microsoft, Amazon, Alphabet, Meta, Nvidia (its market cap just topped $US4 trillion), Tesla and Broadcom. These MAG-8 stocks comprise more than 35 per cent of the S&P 500 and nearly 25 per cent of the MSCI World Index. Their price moves increasingly drive overall returns and volatility. Index design and capital flows reinforce this skew. Headline diversification can disguise the true drivers underneath.

The MAG-8 delivers: real profits, sustained growth. The inevitable AI shift has even led some to call them “defensive”. But valuations remain extreme, and dominance always feels permanent. Cisco and GE once wore the same crown.

Australian benchmarks show similar concentration. The S&P/ASX 200 leans on four banks: CBA, Westpac, NAB and ANZ. Together they comprise nearly a quarter of the index. CBA alone can weigh more than 11 per cent. These banks are exposed to credit growth, rates and the housing cycle.

Benchmark risk here is not new. Resources once held the same title. Earlier cycles reflected export dependence. Today, it is domestic policy and household leverage that drive the index. Dominance shifts. BHP once wore that mantle in the S&P/ASX 200, just as GE and Cisco did globally. The title changes. The concentration remains.

Idiosyncratic risk affects single companies. Sectoral risk is broader, tied to policy shifts like digital tax, housing leverage or regulation. In top-heavy indices, these risks converge. A housing downturn or rate spike can drag down the ASX benchmark. The MAG-8 faces regulatory scrutiny, tax risk and monopoly pressure. Benchmark exposure turns sector risks into market-wide events.

Bond portfolios are exposed in similar ways. The FTSE World Government Bond Index gives more than 40 per cent to US Treasuries. Liquidity and scale shape the weightings. Political decisions, deficits and trade settings drive risk. In super funds, international bonds are usually hedged, anchoring risk to interest rates and credit quality.

International equities

International equities are mostly unhedged. The MSCI World Index is more than 70 per cent US-listed. Most super funds hold 20 to 50 per cent in international stocks, largely in US dollars. This creates large unhedged currency exposure. Since the 2024 US election, the US dollar has fallen seven to 10 per cent against most major currencies. These moves can and do reshape international share valuations. Portfolio risk can therefore be compressed into US dollar exposure and US policy.

The US dollar’s role as reserve currency has long provided ballast. In passive portfolios, it becomes a single point of vulnerability. A weaker US dollar or shift in capital flows may amplify drawdowns. The structure of large passive holdings embeds that risk.

Size dictates weight. Passive portfolios allocate by capitalisation, not conviction. This magnifies exposure to the largest names. Passive selling hits the most crowded names hardest. Liquidity thins where ownership is heaviest. Volatility can appear baked into the structure.

Balanced portfolios rest on structural assumptions. They promise offsetting behaviour and low drawdowns. Most target CPI-plus-three per cent, no more than one-in-seven negative years and shallow corrections. These promises depend on risk factors acting independently. That separation weakens when both bonds and equities are driven by the same concentration forces. The portfolio may hold thousands of securities, but the true number of risk drivers remains small.

Regulation has now cemented the crowding. The Australian Prudential Regulation Authority (APRA) benchmarks super funds against peer outcomes rather than long-term objectives. This pushes CIOs to remain close to the benchmark. Peer deviation becomes a career risk and narrows decision-making. Diversification is subordinated to relative performance. These peer-based comparisons are published and enforced through APRA’s performance ‘heat maps.’ Funds that fall short risk sanctions or reputational damage.

These exposures are widely shared. Buybacks and algorithms reward scale. Through supposed risk metrics like tracking error constraints, managers often stay close to the same indices. Regulators use the same heat maps. Portfolios orbit the same nodes. Apparent choice masks common exposure.

Retail investors

Retail investors are shaped by this as well. Superannuation and exchange-traded funds (ETFs) channel capital to the same points. The MAG-8, CBA and US Treasuries drive returns for millions. Most super members assume diversified holdings reduce risk. In reality, many portfolios share the same triggers and move together during shocks.
 
Risk models lean on history and asset labels. These tools lose effectiveness when portfolios respond to the same triggers. The buffer looks wide but is often shallow.
 
Diversification today is often misunderstood and mismeasured. Dominance risk and compressed exposures shape outcomes. Fiduciaries, regulators and asset owners need to engage with actual risk structure. This means rethinking benchmarks, revisiting weightings and pursuing portfolios built on independent risk sources. Factor models and minimum volatility strategies help reconnect return to real diversification.
 
Australia’s superannuation system now exceeds $4 trillion. That scale carries real macroeconomic weight. If risk is misread or mismanaged, consequences ripple beyond portfolios. Compressed exposures and passive crowding are no longer just portfolio-level issues. They shape the system.