Exchange Traded Funds (ETFs) that track an index have grown in popularity in recent years. You can get an ETF for just about anything, including oil, gold, cybersecurity, and more generally popular indexes like the S&P500 or the S&P/ASX200 (INDEXASX: ^AXJO) (ASX: XJO).
They are popular ways to get passive exposure to the share market, and funds like Vanguard or Blackrock often have attractively low fees, which can make these products popular among Self-Managed Super Fund (SMSF) and hands-off investors.
However, there are several key reasons to be wary of indexes that track the ASX:
- Heavy concentration in a small number of industries
Commonwealth Bank of Australia (ASX: CBA), Westpac Banking Corp (ASX: WBC), Australia and New Zealand Banking Group (ASX: ANZ), and National Australia Bank Ltd. (ASX: NAB) together account for a fraction over 26% of the ASX 200. Macquarie Group Ltd (ASX: MQG), another banker, takes that number to 28%.
Rio Tinto Limited (ASX: RIO), BHP Billiton Limited (ASX: BHP), Fortescue Metals Group Limited (ASX: FMG) and Newcrest Mining Limited (ASX: NCM) – plus a few smaller miners – account for ~9% of the index. Woodside Petroleum Limited (ASX: WPL), Santos Ltd (ASX: STO) and Oil Search Limited (ASX: OSH) make up another 3%.
Straight away we've got 28% of the index in banking, and another 12% in resources. The rest is pretty diverse, with a mix of insurers, construction companies, manufacturers, and utilities, rounded out by a handful of retailers, technology and healthcare companies.
- It's all interconnected
Unlike larger or more industrially diverse countries, Australia is small and concentrated enough to feel it when one sector weakens. If resources collapse, that drags down employment and the banking sector – and just about everything else. There's very little in the way of technology or healthcare to generate growth over the long term. With 40% of the index in cyclical industries (even more if you own ASX100 or ASX50 ETFs) any investor is strongly exposed to cyclical ups and downs.
(For more information on general risks associated with ETFs and index funds, you can read our recent articles here and here)
Oddly enough, the ASX200 index looks a lot like an ideal retiree's investment. It's heavy on the companies with strong market positions and ability to generate cash throughout the cycle – even if they look ugly at the bottom.
Foolish Takeaway
This is not to say that you should steer clear of ASX-tracking ETFs entirely, but readers do need to be aware of what they own or are buying. If you already own the banks and miners, I categorically would not buy an ASX-tracking ETF. Spread your eggs out into a few different baskets, and consider some non-financials investments like CSL Limited (ASX: CSL) or even Wesfarmers Ltd (ASX: WES).
