Exchange Traded Funds (ETFs), indexed to major benchmarks such as the S&P/ASX 200 (ASX: XJO), provide diversification in a portfolio that is concentrated in a small number of shares. Also, providing the opportunities to diversify offshore and invest in companies that are under-represented in the Australian market. ETFs also allow investors to trade more efficiently, which may support criticism that ETFs are responsible for increasing market volatility and destabilising the market but it is yet to be substantiated. Even the critics cannot ignore the fact that investors get a better deal regarding fees, and all areas of the investment management industry have been forced to take notice and become more competitive on the fee front.
Not all ETFs are indexed and the benchmark used is not always a standard one. There are many indexes, but most money is concentrated in broad indexes, which also results in the ETF being more exposed to the largest companies. This scenario may not be ideal when of the top five companies, four companies are all in one sector such as the big four banks, although BHP Billiton Ltd (ASX: BHP) is heading towards being larger than Commonwealth Bank of Australia (ASX: CBA) by market cap.
Three of the largest ETFs in Australia by market cap are SPDR 200/ETF (ASX: STW), V300AEQ/ETF known as Vanguard Australian Shares Index ETF (ASX: VAS) and ISCS&P500/ETF (ASX: IVV). SPDR 200/ETF Fund and Vanguard Australian Shares Index ETF are benchmarked to broad market indexes such as S&P/ASX 200 (ASX: XJO) or S&P/ASX 300 (ASX: XKO). ISCS&P500/ETF is benchmarked to the S&P 500 Index in the US, and the three top holdings are Apple Inc, Microsoft Corp and Amazon Com Inc, which are around 10% of the portfolio. Beta shares has one of the lowest cost ETFs, the BetaShare Australia 200 ETF (ASX: A200), which provides Australian broad sharemarket exposure with management fees of 0.07% per annum.
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Motley Fool contributor Rosemary Steinfort owns shares of BHP Billiton Limited. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.