Optimal Domestic Equity Allocations for Australian
Investors and the Role of Franking Credits

Abstract

Private investors around the world tend to have an excessive preference for shares of companies based in their home country. This home bias may be further strengthened if domestic equities receive preferential treatment by local tax laws. Australia’s franking credit system is one example of preferential treatment for domestic equities. Franking credits reduce investors’ tax liability on the dividends received from domestic companies but not on those from foreign companies. This tax advantage, and the solid performance of the Australian equity market over years, has led to very high, even excessive, allocations to domestic equities in the portfolios of Australian investors. In this article we describe how this strong preference for domestic equities can erode the wealth of Australian private investors over the long term and propose an optimal allocation to domestic equities for Australian investors.

TOPICS: Wealth management, portfolio construction, developed, legal/regulatory/public policy