Should investors looking for diversity go for the Vanguard International Shares ETF (VGS)?

This ETF might not be as diversified as it seems.

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At first glance, the Vanguard MSCI Index International Shares ETF (ASX: VGS) looks like the perfect exchange-traded fund (ETF) if one is looking to add some diversity to an ASX share portfolio. After all, most investors looking to diversify a portfolio look to international share markets.

Not only can you use these to buy companies that operate outside Australia, but you can also diversify when it comes to currency.

And ETFs are a perfect vehicle to do so. They offer access to a range of investments, all under one fund, with one ticker code.

But just how diversified is the VGS ETF? That's what we'll be looking at today.

Right off the bat, it looks as though this Vanguard ETF has all anyone is looking for in a diverse ETF. Vanguard tells us its International Shares ETF offers exposure to more than 1,450 individual shares, collectively hailing from more than 20 advanced economies around the world. These range from Japan, the United Kingdom and Finland to Singapore, Hong Kong, and Israel.

So case closed, right?

Well, not exactly. A deeper dive into this ETF's foundations paints a far different picture.

Just how diversified is the ASX's VGS ETF?

All of the statistics above are technically correct. But this ETF is not an equal-weight fund. That means although it offers exposure to 1,451 individual companies, the weightings of said companies differ according to their market capitalisation.

The largest company commands a portfolio weighting of 5.04% in the VGS portfolio. The smallest? Just 0.00017%. That means that even if you dropped $10 million into ASX VGS units today, you'd only have $17 invested in its smallest holding.

In fact, the top five companies in this ETF (0.34% of 1,451) account for approximately 14.88% of the VGS portfolio. That's probably not what anyone picturing a portfolio of 1,451 shares would have in mind.

It gets worse (from a diversification perspective) though.

Let's talk about those 20-plus countries that VGS draws its portfolio from. Once again, that looks great. However, digging deeper, you'll find that while that is technically accurate, one country alone accounts for 71.1% of VGS's weighted portfolio.

So out of that $10 million, roughly $7.1 million would be invested in a single market. That is the United States of America, of course. Yep, 71.1% of this portfolio's weighting is towards US shares. In fact, the top 20 shares of the fund are US stocks.

The top five holdings we mentioned earlier are:

  1. Apple Inc (NASDAQ: AAPL)
  2. Microsoft Corporation (NASDAQ: MSFT)
  3. Inc (NASDAQ: AMZN)
  4. Alphabet Inc (NASDAQ: GOOG)(NASDAQ: GOOGL)
  5. NVIDIA Corporation (NASDAQ: NVDA)

So not only are the top 20 VGS stocks US shares, but the top five are all US tech shares.

How's that for diversity?

Thus, the reality is that the Vanguard International Shares ETF is not really a diversified fund when the rubber hits the road. It is essentially a big ol' bowl of US tech giants and stocks, with some international spice thrown in on top.

This is just a lesson to never judge an ETF by its cover. You might not get what you think you are paying for.

Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. John Mackey, former CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Motley Fool contributor Sebastian Bowen has positions in Alphabet, Amazon, Apple, and Microsoft. The Motley Fool Australia's parent company Motley Fool Holdings Inc. has positions in and has recommended Alphabet, Amazon, Apple, Microsoft, Nvidia, and Vanguard MSCI Index International Shares ETF. The Motley Fool Australia has recommended Alphabet, Amazon, Apple, Nvidia, and Vanguard MSCI Index International Shares ETF. 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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