For investors constructing multi-asset portfolios, both top-down asset allocation and bottom-up stock selection remain critical drivers of risk and return. The interplay between the two is particularly important when dealing with large, concentrated exposures to distinct risk premiums – like Australian banks.

For a typical Australian growth fund targeting a 30% allocation to domestic stocks, the big four banks alone could represent 10% of the total portfolio. While the banks may seem attractive on some stock-specific metrics, the asset allocator needs to seriously weigh the impact of such a large factor bet.

Head of Australian Equities Tim Binsted and Director Jonathan Ramsay explain that most analyst valuations are 30% to 40% below Commonwealth Bank’s (CBA) current share price — highlighting just how stretched its valuation appears. CBA is also priced at a 60% premium to the broader market based on price-to-earnings ratios, despite only delivering low single-digit growth. That means the investment case relies on an already expensive stock getting even more expensive — a risky bet. The return potential looks unbalanced, with much more room for the share price to fall than rise, especially if market valuations come back down. To put this in perspective, getting the same level of risk from a country exposure would require investing in nearly the entire world outside the U.S.

From an asset allocation lens, there are several considerations. Firstly, does this level of idiosyncratic stock risk align with the investor's risk tolerance and investment objectives? Even well-run, blue-chip companies can face sudden changes in operating environment or competitive dynamics. Secondly, how diversified are risk exposures across the portfolio? Outsized bets on particular risk factors like leveraged financials can leave investors vulnerable to sharp drawdowns in certain macro scenarios.

At the same time, it’s important not to overly limit the role of individual stock picking. Sometimes, a single stock can trade well above or below its fundamental value for longer than a whole country or sector — often for unique, company-specific reasons. If a portfolio has room for this kind of risk, well-researched, high-conviction positions can add real value. The key is to manage the size of those bets carefully and make sure they’re balanced with other sources of return.

The ideal approach blends both big-picture (top-down) thinking and individual stock analysis (bottom-up). A strong asset allocation strategy sets the overall structure — including how much risk to take and how much return is needed to justify concentrated positions. Within those limits, choosing the right individual investments can still add meaningful value when done carefully. Right now, most stock pickers, analysts, and asset allocators agree that CBA’s current share price is hard to justify — which raises the question of what’s keeping it so high. CBA is the largest stock in the local market. Its valuation premium, combined with tepid earnings growth, suggests considerable downside risk and underscores the value of marrying bottom-up and top-down processes when making allocations to Australian equities

For investors thinking about how to manage exposure to areas like Australian banks, there are a few options. One approach is to reduce overall share market exposure and shift into areas that offer better value and less risk. Another is to stick with the broader investment strategy but lean towards sectors or companies with stronger long-term prospects. The right choice depends on each investor’s goals and how much active risk they’re comfortable taking. At InvestSense, we look closely at the underlying exposures in each portfolio — and in cases like this, we’ve taken extra steps to make sure our asset allocation process is even more detailed and responsive.

The key is to make sure the risks in your portfolio are intentional, well-rewarded, and diversified. Combining a disciplined big-picture view with thoughtful company-level analysis — all while keeping sight of the overall risk and return — is how long-term investors can stay on course through changing markets.