Allan Gray exposes 'hateful eight' bubble threat

Allan Gray chief investment officer Simon Mawhinney has sounded the alarm that the Australian stock market is dangerously concentrated, with the 'Hateful Eight' companies - the big four banks, Macquarie, Wesfarmers, Goodman Group, and Aristocrat - racking up 85% of last year's returns despite representing just 28% of total market capitalisation.

Mawhinney, speaking at the Allan Gray Australia and Orbis Investments investment forum, noted that the Hateful Eight generated a 35.6% return over the past year, while the remaining 292 stocks in the ASX 300 scraped together 2.2%.

It's the same story over the past three years as well, he said, with the Hateful Eight delivering a 52% return while the remaining 292 stocks mustered a "paltry" 11.3%.

Having dominated stock market returns over the past three years, which has further increased their weight in the ASX 300, he said there's clear evidence concentration risks are abound.

"The Australian index is now extremely concentrated. Passive, index investors are currently knowingly or unknowingly allocating a huge part of their exposure to banks, which are trading at eyewatering valuations. A purely passive approach may leave you exposed..." Mawhinney said.

Allan Gray believes investors in the local share market can't afford to ignore valuation risk, while those looking globally will need to push beyond their comfort zone if they want to achieve outperformance.

"The recent period of strong share market performance and price insensitive investment flows appears to have led to significant market dislocation and stretched fundamentals. Trade tensions, populist politics and monetary policy have become front-of-mind distractions, shifting attention away from long-term fundamentals," Mawhinney said.

Notably, that the Allan Gray Australia Equity Fund is underweight the large companies dominating the index due to its contrarian investment style, resulting in what it says is a "more diverse range of performance drivers."

The fund trades at a 14.7x P/E ratio compared to over 19x for the ASX 300.