Which ASX ETFs offer the most diversification?

Does the Vanguard Australian Shares Index ETF (ASX: VAS) offer sufficient levels of diversification for an ASX share portfolio?

Block letters 'ETF' on yellow/orange background with pink piggy bank

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Which ASX exchange-traded funds (ETFs) offer investors the most diversification today?

Diversification is one of those investing buzzwords that is probably used a little too much. I penned an article last week on the dangers of over-diversifying a portfolio, which might be worth a look in the context of this article. Even so, diversification remains (in my view) something that most ASX should aspire to in some form. And ETFs are an easy and efficient way of beefing up a portfolio's diversification without too much effort.

The diversification problem with single-market ETFs

But which ETFs to choose? Well, it might seem logical to start with an index fund which tracks the S&P/ASX 200 Index (ASX: XJO), such as the iShares Core S&P/ASX 200 ETF (ASX: IOZ). These are by far the most popular ETFs in Australia, especially if we include the Vanguard Australian Shares Index ETF (ASX: VAS), which tracks the S&P/ASX 300 Index (ASX: XKO).

But these ETFs, although very diversified in their own right, pale in comparison with some other ETFs out there. For one, they hold either 200 or 300 companies in just the Australian market. In contrast, something like the Vanguard U.S. Total Market Shares Index ETF (ASX: VTS) holds more than 3,500 US shares. That's more than 10 times as many different holdings than IOZ or VAS.

But all of these ETFs only track one single market (albeit with massive diversification within them). If an economy-wide malady, such as a national currency collapse, were to affect one of these markets, there could be insufficient diversification to protect investors.

So where to turn?

Are multi-market ETFs the answer?

Well, there are ETFs that cover multiple markets and countries. The Vanguard MSCI Index International Shares ETF (ASX: VGS) is one such option. VGS is still relatively heavily weighted towards US shares, which make up 68.1% of the funds' 3,466 holdings. However, with more than 20 other countries also represented, at least you have this buffer. Another option is the Vanguard All-World ex-US Shares Index ETF (ASX: VEU), which has a similar number of total holdings, but excludes US shares for a far more balanced portfolio. The country with the most weighting in VEU is Japan, but this only represents 16.9% of the total funds' holdings.

A final option to consider is the Vanguard FTSE Emerging Markets Shares ETF (ASX: VGE). This fund is extremely diversified. It holds more than 5,200 individual holdings across 23 different markets like India, Taiwan, Brazil, Mexico, Chile, Egypt and Greece. However, this fund is heavily weighted towards Chinese companies, which make up 45.2% of the funds' total holdings.

Foolish takeaway

Whilst I think a single market ETF (especially those covering the ASX or US markets) is a great investment for any investor, the reality is that these funds are not completely immune from a lack of diversification. As such, I think if you are heavily concentrated in these markets, a small to mid-size investment in a multi-market ETF might be a good way of adding some extra diversification to your portfolio. It might not be for everyone, but if it helps you sleep better at night, it might well be worth it.

Motley Fool contributor Sebastian Bowen has no position in any of the stocks mentioned. The Motley Fool Australia has recommended Vanguard MSCI Index International Shares ETF. 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.

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