Three Australian shares ETFs that are three very different ways to invest in the same market.

Vanguard Australian Shares Index ETF VAS, VanEck Australian Equal Weight ETF MVW and Betashares Australia 200 Fundamental Value ETF QOZ offer exposure to Australian equities, but the way they weight their holdings creates some surprisingly different portfolios.

In this episode of Investing Compass, we explore market-cap, equal and fundamental weighting, and why the differences matter for diversification, concentration, costs and risk.

You can find the full article here.

You can find the full transcript below:

Shani Jayamanne: Welcome to another episode of Investing Compass. Before we begin, a quick note that the information contained in this podcast is general in nature. It does not take into consideration your personal situation, circumstances, or needs.

Mark LaMonica: We want to once again repeat the competition, which is very exciting. So anyone who’s read the book, leave us a review. The review can be from wherever you purchased it. So it could be Amazon, could be Goodreads if you want a general review, it could be Audible if you listen to the audio book. So leave us a review, take a screenshot, send it to my email address, that’s in the show notes, and we will randomly draw a winner, and the winner gets a meal. And there are two choices for the meal. There is you can get a $300 gift card to just go out and eat by yourself for someone you want to go out with. Or you can go to lunch with the two of us in Sydney. We will not pay for travel costs. We’re told by compliance to say that. Although it should be obvious. So if you’re in Sydney or if you’re going to be in Sydney at some point, you can go out and have a meal with us.

Jayamanne: How do you think this compares to the lunch that Warren Buffett auctions off?

LaMonica: Well, it’s a little bit different because we’re not asking people to bid for this. I assume we would get approximately the same amount of money as Warren Buffett.

Jayamanne: Okay.

LaMonica: Well, Buffett doesn’t have great taste in food.

Jayamanne: I think he has okay taste in food.

LaMonica: He goes to McDonald’s every day.

Jayamanne: Yeah. But your lunch or dinner will not be at McDonald’s if you do choose to dine with us.

LaMonica: No, no. We have very sophisticated pallets. And the venue will reflect that. All right. Let’s get into today’s episode. We’re going to talk about ETFs today, Shani.

Jayamanne: Yes.

LaMonica: So take it away.

Jayamanne: So more and more investors are using ETFs in their portfolios, and many are using ETFs as their core building blocks in their portfolio. So you can own hundreds of companies with one trade when you buy an ETF. So what’s not to like, Mark?

LaMonica: Well, there is a catch, Shani. The number of companies that are in an ETF, of course, do not tell you how diversified it is. So what matters is how much of your overall investment in that ETF, how much of that is allocated to the different companies that it holds. So two ETFs can hold many of the same companies and still give you very different portfolios depending upon how they weight those holdings.

Jayamanne: And this diversification problem is particularly an issue in Australia. Our market is heavily skewed towards the top holdings, and the market is dominated by a relatively small number of large banks and mining companies. You’re not getting much diversification there.

LaMonica: So if you are holding a Australian equity ETF, you’ve either consciously or inadvertently made a choice. It’s pretty likely that you’re going to hold a market capitalization weighted index. So that means that the allocation of your investment in that ETF goes to the larger or disproportionately goes to the larger companies in the index. And this is where that concentration problem is happening.

Jayamanne: But there are other ways to weight an ETF. Market capitalization isn’t your only option. So today we’re going to explore those options. We’ll start with market cap, but we’ll also cover equal weighting and fundamental weighting.

LaMonica: So we are going to talk about three different types of Aussie equity exposure that you can get through ETFs. All three will give you exposure to the Australian share market, but they do result in very different portfolios.

Jayamanne: And to do this, we’re going to look at three different strategies and take a look under the hood of each of them. So Vanguard Australian Shares Index ETF with the ticker symbol VAS, Van Eck Australian Equal Weight ETF, MVW, and BetaShares Australia 200 Fundamental Value ETF with the ticker QOZ.

LaMonica: It’s almost like when people name these ETFs. They don’t imagine anyone’s going to have to say this stuff out loud.

Jayamanne: Or like several in a row.

LaMonica: Exactly. So we’ll start with the very basic, we’re going to start with the market cap. As we said before, the larger companies get a larger allocation. So this is how most broad-based Australian ETFs work. And it works under the premise that size is a good indicator of value. The most popular ETF in Australia, which Shani mentioned, the Vanguard Australian Shares ETF, ticker symbol, VAS. That tracks the ASX 300. That’s weighted according to the market value of the companies it holds. Your exposure to a company increases when its share price rises and the market capitalization of that company becomes larger.

Jayamanne: And VAS is simple and inexpensive. The implementation costs tend to be significantly lower than other approaches because market cap requires relatively less portfolio management and generally incurs less transaction costs.

LaMonica: So if we look under the hood, financial services makes up 31% of the ETF, basic materials, which are the miners make up 27% of the ETF. And the result is that owning an Australian broad market ETF doesn’t mean you’re spreading your money evenly across the Australian economy or across many sectors and industries.

Jayamanne: And I think the lesson here with market cap that’s relevant, but also in markets like the US is that investors shouldn’t conflate broad with diversified. There are differences between the number of underlying holdings in an ETF and how much influence each has. An ETF like VAS can hold 300 holdings while having a large proportion of its assets concentrated in its largest holdings. Its top 10 holdings represent 47% of the fund.

LaMonica: Yeah, and this is not some sort of flaw in the allocation or an error in the index. The index is doing exactly what it’s supposed to do. Market cap weighting is designed to represent the market as it exists. If CBA becomes more valuable, its weight increases. If BHP’s market capitalization grows, your exposure to BHP increases.

Jayamanne: And that’s the appeal of the strategy. It is transparent, rules-based, and requires relatively little turnover. It also means the composition of your portfolio can change considerably without you making a single trade.

LaMonica: All right. So let’s move on, Shani. We’re going to move on to equal weight. That takes a very different approach, which you can probably guess just by the name of the ETF. So instead of allocating to the biggest companies that tend to dominate these indexes, it gives each company roughly the same allocation.

Jayamanne: So the Van Eck Australian Equal Weight ETF with the ticker symbol MVW is an example. Its underlying index equally weights its constituents, so it reduces the influence of the largest companies. So in a market like Australia, where we have a significant concentration to two industries, equal weighting tempers that exposure. It also reduces concentration in the largest companies. Australia’s two largest listed companies, BHP and CBA, make up over 20% of the ASX 300 at the end of September. The other 298 companies make up the other 80%.

LaMonica: And there are several different roles that an ETF like this can play in a portfolio. So one, if you just simply are concerned about market capitalization weighted indexes, that might be a reason to invest in this. The other reason is potentially in your portfolio, you hold a fair size holding of one of these large companies in Australia, and you don’t want to double down. So, instead, you want to hold an equal-weighted index, so that you’re not doubling down on BHP or CBA or anything else. Or you could simply have an issue with some of the large companies and think they’re overvalued.

Jayamanne: So MVW generally holds around 70 to 100 companies compared with 300 in the ASX 300 ETF. The investment evenly spreads the allocation across these companies, increasing exposure to medium-sized businesses. And Morningstar analysis has found that the average market cap of MVW’s portfolio is less than half that of traditional market cap weighted Australian equity products. Its financial exposure is also materially lower than the ASX 300.

LaMonica: Yeah, so it’s important to know that an equal weighted ETF doesn’t simply give you a more diversified version of exactly the same portfolio. It changes what you own. So Shani, you wrote an article on this. We’ll put a link in the show notes, and you have a lot of analysis on these three ETFs. So sector weightings, all the different exposures that we’ve talked about. So you can compare and contrast them and see how your portfolio would look depending upon how much you put into these ETFs. The differences mean that a portfolio can behave quite differently under different market conditions. And that’s certainly true with an equal weighted ETF and a market cap weighted ETF.

Jayamanne: There’s also another important consequence that we’ve got to mention about this strategy. An equal weighted ETF needs to remain an equal weighted ETF. Markets move and companies will grow and others will shrink. So the ETF needs to rebalance to get back to its target weights.

LaMonica: So systematically, equal weighted ETF is doing something that a market cap weighted ETF is not. So it sells the relative winners and buys relative losers. And that can create value and size tilt, a value and size tilt over time. But it also means that there is more trading in these ETFs.

Jayamanne: So MVW, for example, has annual turnover of around 35% compared with the relatively low turnover typically associated with market cap weighted index strategies. Turnover can have implications for transaction costs and the capital gains distributed by a fund. What you get for that is a more diversified portfolio with less concentration in large companies.

LaMonica: And there is, of course, additional work from the ETF provider to manage these portfolios, and that is reflected in the fees that you’re going to pay. So the case of MVW, the fee is 0.35%. And that compares to a 0.07% management fee for that market capitalization weighted ETF VAS that we talked about earlier. So ultimately, it’s not just different exposure, it’s also a different investment strategy as well.

Jayamanne: So lastly, there’s fundamental weighting, which sits somewhere else again, instead of weighting companies according to their share prices, uses measures such as sales, cash flow, dividends, and book value to determine their weight.

LaMonica: So the example that we’re going to go through today is BetaShares Australia 200 Fundamental Value ETF with the ticker symbol QOZ and it uses – Q-O-Z, sorry.

Jayamanne: I said Z at the beginning as well, so you are forgiven.

LaMonica: You did.

Jayamanne: I did.

LaMonica: My Americanism is rubbing off on you, apparently. So Shani mentioned, QOZ uses a fundamental weighting approach. So the methodology weights companies according to their fundamental size rather than their market cap. There is one important caveat we want to say that this ETF very recently, as of the time that we’re recording, switched indexes. So it’s tracking a different index according to BetaShares. That does make no material difference in the ETF, but it is something you might want to look into. So the historical index is different from the index going forward.

Jayamanne: So QOZ uses fundamental measures, including sales, cash flow, dividends, and book value to determine the size of its holdings. And what this does is break the direct relationship between a company’s share price and its weight in the portfolio. So it can create a value-oriented portfolio because companies whose market price has fallen relative to their fundamentals can receive a larger weighting.

LaMonica: So at the beginning of this episode, Shani spent some time talking about that concentration in the Australian market and of course the concentration, market capitalization, weighted ETFs. And as an alternative strategy, we do, of course, want to remind people that this fundamental weighting can produce different exposures and different concentrations. So once again, we do want to sit there and look at that. So September 2026, for example, QOZ’s largest holding was BHP at 15.3% of the ETF. So that is actually more concentration than we saw in the market cap weighted ETF, where at the same time period BHP made up 11.78% of that Vanguard Australian shares ETF. So that comparison of all the top holdings is in Shani’s article, which is in the episode notes if you want to take a closer look.

Jayamanne: And I think an important point to make here is that people are not day trading broad market Australian equity ETFs. That exposure is almost always used as a core holding for investors over the long term. And these ETFs offer three options for weighting and exposure to the Australian market.

LaMonica: And so company concentrations, sector allocations, growth and value characteristics, tax implications, fees, they all look different when you’re looking at these different strategies in the ETFs that are following them. And those differences can persist for years into the future and have a big impact on your investment outcomes. So you will end up with really different results and outcomes in your portfolio.

Jayamanne: And like with any other investment comparison, it is tempting to attempt to pick a winner, but you need to consider what exposure best suits the goals of your portfolio. All right.

LaMonica: So market capitalization weighted big advantages are simplicity and low cost. It lets the market determine the allocation. There’s very little turnover in those portfolios. Equal weighting reduces the concentration in the largest companies, but it introduces greater exposure to smaller and medium-sized companies. There is regular rebalancing, which does have tax and cost implications. Fundamental weighting attempts to anchor the allocations to measures of a company’s economic footprint rather than its market price. But you need to understand how it’s calculating those weightings. And you do need to understand that this also can potentially result in substantial value and sector tilts depending upon that criteria.

Jayamanne: And each of these approaches can look better or worse depending on what’s happening in the market.

LaMonica: So you’re not just buying a basket of securities when you buy an ETF. You are buying an investment strategy and that determines how much of each company you own and your exposure to different parts of the economy over the long term. So thank you very much for listening. Anyone wants to enter that competition, it will be exciting if we actually have multiple people to draw from. So thanks for listening.

(Disclaimer: Any advice in this podcast is general advice or regulated financial advice under New Zealand law prepared by Morningstar Australasia proprietary limited and/or Morningstar Research Limited without reference to your financial objectives, situations, or needs. You should consider the advice in light of these matters and any relevant product disclosure statement before making any decision to invest. To obtain advice for your own situation, contact the financial advisor.)

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