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3 equity ETFs to get you started

Emma Rapaport  |  14 Jul 2021Text size  Decrease  Increase  |  
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There's a lot to like about passive exchange-traded funds. They're easy to buy and sell; they're comparatively low-lost; they offer instant diversification into global equity and bond markets; they’re transparent. Exchange-traded funds (ETFs) can be terrific portfolio building blocks for your portfolio, as we explored in our two-part series on how to build a core/satellite portfolio.

Today we delve further into some of those 'core' funds that could form the backbone of a diversified portfolio. We've used the Morningstar ETF Screener to filter for:

  • Australian and international equity ETFs
  • Management style = passive
  • Morningstar Analyst Rating of Gold, Silver or Bronze
  • Morningstar Sustainability Eating <average
  • Equity style box = 'large cap, blend'*
  • Management fee <0.5% p.a.

All these funds have earnt a Morningstar Analyst medallist rating (Gold, Silver or Bronze) meaning that they score highly on five key metrics: people, process, performance, parent and price. The Analyst Rating is the outcome of a collaborative process based on a site visit, analyst questionnaire, quantitative and holdings-based analyses of the portfolio. Funds that earn a Gold rating are those that analysts think are most likely to outperform over a full market cycle.

*The blend style is assigned to portfolios where neither growth- nor value-characterised stocks predominate.

Australian equity exposure | Vanguard Australian Shares ETF VAS

  • Category: Australia & New Zealand Equity
  • Primary Prospectus Benchmark: S&P/ASX 300 TR
  • Fund size: $8.8 billion
  • Management fee: 0.10%
  • Morningstar analyst rating: Bronze
  • Morningstar sustainable rating: Average (3 globes)
  • Number of equity holdings: 307
  • Percentage of assets in the Top 10 Holdings: 45%
  • Total Return 10-Yr Annualised: 9.01%

-- Morningstar fund analyst Edward Huynh

Vanguard Australian Shares Index offers investors broad-cap diversified exposure to the Australian equities market at very low cost. VAS aims to track the S&P/ASX 300 Accumulation Index, a free-float-adjusted, market-cap-weighted index. It is one of Australia's best-known stock market benchmarks and covers about 85% of Australian equity market capitalisation.

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While the S&P/ASX 300 Index is dominated by giant- and large-cap companies, the fund has exposure to small caps, with an approximate weighting of 7.5%. The portfolio is top-heavy, with about 29% of the index in the top five companies. The concentration in banks skews the fund's sector weightings, with financial services forming around 26% of the portfolio. Some sectors that are prominent on the global stage are underrepresented in the Australian market. Technology and to a lesser extent healthcare combined make up around 17% of the index--a lower proportion than equivalent US and European indexes.

Fee competition is rife in the increasingly commoditised passives market-cap space. At 10 basis points, it is one of the cheaper ways to get access to the Australian equity markets, easily less expensive than active rivals, though not the cheapest in the market.

Low portfolio turnover adds to this vehicle's tax effectiveness versus active strategies. The index is rebalanced twice per year in March and September though increased market volatility during early 2020 has resulted in rebalancing delayed until June.

Overall, we believe that the best active managers can beat the benchmark consistently over time, though the hurdle is quite high, and evidence suggests most falter. Vanguard Australian Shares Index is a good option for those seeking passive broad-cap exposure to the Australian equity market at a low cost.

World developed-markets equity exposure | Vanguard MSCI Intl ETF VGS

  • Category: Global Equity Large Cap
  • Primary Prospectus Benchmark: MSCI World Ex Australia NR AUD
  • Fund size: $3.4 billion
  • Management fee: 0.18%
  • Morningstar analyst rating: Silver
  • Morningstar sustainable rating: Average (3 globes)
  • Number of equity holdings: 1499
  • Percentage of assets in the Top 10 Holdings: 17%
  • Total Return 10-Yr Annualised: -

-- Morningstar fund analyst Kongkon Gogoi

Vanguard MSCI International ETF VGS is a compelling choice for investors seeking world developed-markets equity exposure at a low cost. With over 1,500 stocks constituting the index, the MSCI World ex Australia is a widely popular barometer for the world developed-markets equities. The index indeed has country concentration risk (the United States forms 68% of the index), but a high allocation to the US is a common feature across most global indexes. Helping mitigate this risk is the fact that many of the large US stocks are multinationals (Apple, Microsoft, Amazon, Alphabet, Facebook, and so on), earning substantial percentage of their total revenue from international markets.

The constituents of the index are well known and are generally the leaders in their respective industries with a high degree of analyst coverage and plethora of public information made readily available. This, compelled by intense competition among investors, has led the prices of the underlying constituents to factor in all available information more quickly, thus making the large-cap market segment more efficient over time. Sector spread is another aspect that supports the investment case here. Underrepresented sectors in Australia such as information technology and healthcare are well represented in the MSCI World ex Australia with over 35% of the index as of 31 Oct 2020.

The strategy has faithfully tracked the benchmark over time with just 0.04% of tracking error for the trailing five years through 31 Oct 2020. However, Vanguard doesn't mimic the index blindly; the team allows some deviation when trading costs are prohibitive--for example, around index changes or illiquid stocks.

The strategy's significant assets under management provide benefits of scale and help keep a lid on the trading costs. With an incredibly low fee of 0.19% per year, the fund has a substantial price advantage over peers.

For investors seeking developed market large and mid-cap equities exposure, VGS must be considered for its price advantage, liquidity, portfolio diversification, and a track record of effective implementation.

Dedicated US equity exposure | iShares Core S&P 500 ETF IVV

  • Category: US Equity Large Cap Blend
  • Primary Prospectus Benchmark: S&P 500 NR AUD
  • Fund size: $4.6 billion
  • Management fee: 0.04%
  • Morningstar analyst rating: Silver
  • Morningstar sustainable rating: Average (3 globes)
  • Number of equity holdings: 509
  • Percentage of assets in the Top 10 Holdings: 28%
  • Total Return 10-Yr Annualised: 18.8%

-- Morningstar fund analyst Kongkon Gogoi

IVV seeks to emulate the risk-profile of the S&P 500 at an incredibly low cost of 0.04% per year, standing out as an excellent choice for passive US large-cap equity exposure.

IVV tracks the S&P 500, a free-float, market-cap-weighted benchmark composed of large-cap US equities. Constituents are determined by a set of criteria and an index committee. The minimum market cap for companies in the index is about US$5 billion. A slight quality tilt exists because of its conservative eligibility requirements pertaining to unprofitable companies and recent IPOs.

Sector diversification is another aspect supporting the investment case here. The ETF gives exposure to a broad portfolio of some of the world’s most well-regarded companies, including sectors that are underrepresented in Australia, such as technology and healthcare. The S&P 500’s correlation to Australian equities has come down in recent years, effectively adding to diversification for Australian equities exposure.

Our conviction in the strategy to deliver long-term outperformance remains intact. Often recognised as the barometer of the US equity market performance that effectively diversifies risk and sets a high hurdle for active managers to beat, the S&P 500 represents one of the most efficient and liquid equity asset classes in the world.

For investors seeking a dedicated US exposure, IVV must be considered for its price advantage, liquidity, diversification, and a long track record of effective implementation.

Click here to see the full list of Australian exchange-traded funds and here for Morningstar's coverage list.

is the editorial manager for Morningstar Australia. Connect with Emma on Twitter @rap_reports. You can email Morningstar's editorial team editorialAU[at]morningstar[dot]com

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