As the name suggests, the S&P/ASX 200 Index (ASX: XJO) contains 200 companies. Investors who buy the BetaShares Australia 200 ETF (ASX: A200), which tracks this index, presume they are gaining a high level of diversification.
However, this isn't the whole story. There are two key factors to consider.
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Weighted by market capitalisation
Firstly, while it's true that the BetaShares Australia 200 ETF contains 200 holdings, they are not equally weighted. Rather, they are weighted by market capitalisation, which means larger companies are given the biggest representation.
Recently, concentration has magnified, with Australia's largest companies becoming even bigger. For example, Commonwealth Bank of Australia (ASX: CBA) now represents around 12% of the index.
A material decline in CBA's share price would significantly impact the A200 ETF. With Macquarie Group Ltd (ASX: MQG) placing a price target of $105 on the stock, a sharp decline over the next 12 months is certainly plausible. A200 ETF investors should keep this in mind.
Sector representation
Secondly, certain sectors are overrepresented in the ASX 200, while others are underrepresented.
Most notably, the financial and mining sectors are overrepresented. As of 20 May 2025, the financial sector made up 35% of the A200 ETF, with the big four banks accounting for 25%. Meanwhile, the technology sector accounts for less than 5% of the A200 ETF.
How to improve diversification?
Given these conditions, A200 ETF investors may be wondering how to improve diversification.
Firstly, they could sell down a portion of their holdings to buy individual underrepresented stocks. For example, The Motley Fool's James Mickleboro recently suggested that Life360 Inc (ASX: 360) could be tipped for a big year in FY26. Morgan Stanley currently has an overweight rating and a $40.00 price target on its shares. Yesterday, they closed at $33.59, suggesting a 19% upside from here.
Of course, ASX investors could also buy US-listed technology shares. Of the Magnificent 7 stocks, Alphabet Inc (NASDAQ: GOOG) (NASDAQ: GOOGL) is currently the most attractively valued, with a price-to-earnings (P/E) ratio of around 20. Buying international shares would also provide the added benefit of geographical diversification.
Another option is to consider an equally weighted ETF such as the VanEck Australian Equal Weight ETF (ASX: MVW). For a management expense of 0.35%, it contains 74 of Australia's largest and most liquid companies.
As the name suggests, its allocations are equally weighted. So, while it does hold the big 4 banks, they are weighted the same as the 70 other holdings. Should CBA shares come crashing down, the MVW ETF will be significantly less affected than the A200 ETF.
