In Australia, the S&P/ASX 200 Index (ASX: XJO) is the benchmark index.
It includes the 200 largest companies in Australia weighted by market capitalisation.
Many investors have a portion of their portfolio dedicated to an ASX ETF that tracks the performance of this index.
However, many investors might not be aware of concentration risk.
Image source: Getty Images
Concentration: the case against traditional funds
Some investors may be unaware that the ASX 200 index is weighted towards just a couple of holdings and sectors because it is market capitalisation based.
A small number of very large companies – especially banks like Commonwealth Bank Of Australia (ASX: CBA) and miners like BHP Group (ASX: BHP) – make up a disproportionately large share of the index due to market-cap weighting.
This means the performance of the "Australian market" is often driven more by a handful of companies than by the broader Australian economy.
A recent report from VanEck highlights this issue.
Investors buying a diversified Australian equity strategy would think it is unlikely that two stocks would be 22% of the portfolio, nor would they think two sectors represent over 50% of the portfolio. This is a risk: Concentration risk.
Nothing highlighted this more than the post-budget fall of CBA. Australia's 2nd largest company fell by over 10% on Wednesday.
So how do investors combat this?
There are several ASX ETFs that use unique strategies to provide a more balanced profile of the ASX 200.
Here are three options to consider.
VanEck Australian Equal Weight ETF (ASX: MVW)
This ASX ETF includes only the largest and most liquid companies on ASX.
It currently includes 76 equally weighted stocks, that are rebalanced on a quarterly basis.
Due to the MVW Index's equal weight construction methodology, at the last rebalance, no company was more than 1.3%. Therefore, MVW, which tracks this index has less stock concentration risk than the ASX 200.
BetaShares Ftse Rafi Australia 200 ETF (ASX: QOZ)
QOZ ETF is another option to target the ASX 200.
It tracks the performance an index that comprises the top 200 companies listed on the ASX. However they are measured by fundamental size.
QOZ is weighted in a way that is reflective of the economic importance rather than the market capitalisation of its constituents.
Constituent weighting is based on accounting values and is known as "Fundamental indexing".
BetaShares Australian Ex-20 Portfolio Diversifier ETF (ASX: EX20)
Many portfolios having a heavy bias towards the big banks and miners. However, EX20 helps diversify exposure away from those stocks and sectors.
It aims to track the performance of an index comprising the 180 largest stocks listed on the ASX, after excluding the 20 largest, based on their market capitalisation.
