Young & Invested: Why some of the most popular ASX ETFs might not be safe
A closer look at the imbalance driving returns in Australia.
Welcome to my column, Young & Invested, where I discuss personal finance and investing for Gen Z and Millennials.
This column aims to be a resource for young investors navigating an ever changing financial, political and social landscape as they try to build wealth. Tune in every Thursday for the latest edition.
Edition 57
According to research from InvestmentMarkets, ETFs have become the most popular investment category, accounting for around 21% of total investor traffic on the platform four months to mid-March.
This doesn’t surprise me. I can’t remember the last time I spoke with a retail investor who didn’t hold at least one ETF in their portfolio. The surface appeal is obvious. They’re cheap, simple and provide instant diversification without the admin of stock‑picking.
There’s a comforting myth in modern investing that if you buy an ETF (any ETF), you’ve somehow transcended investment risk. Against that backdrop, below is a list of Australia’s most popular ETFs.
One could draw a dozen conclusions, but something that stands out is the overwhelming preference for market capitalisation weighted ETFs. These are rules-based funds that allocate holdings based on a company’s relative size. So, if CBA represents 11% of the ASX 200, it will also be 11% of a ASX 200 market cap weighted ETF
Index ETFs or passive funds are simply products that aim to mirror a market rather than outperform it. The most common way they do this is through market cap weighting. The case for index investing is nothing new, with Australia’s first retail index fund launching almost three decades ago. It didn’t spark a revolution at the time, although we’ve since seen a decisive shift away from actively managed funds towards passive.
Market cap ETFs have become a popular option because they appear to solve multiple problems at once. They’re low cost, broadly diversified, tax-efficient and remove the need to make sweeping judgement calls on individual holdings. You don’t have to research several companies and lay idle until they become bargains, nor do you have to pay a fund manager to try doing the work for you.
As product offerings expand, these attributes aren’t necessarily universal, but they’re still the reason market cap funds dominate the league tables.
Whether you’ve previously tried your hand at stock‑picking to beat the market and discovered that you are not, in fact, Warren Buffett, or you’ve only just started investing and prefer being hands off, market cap funds offer a very comfortable solution.
If you can’t beat the market, you may as well buy the whole thing. But that also means inheriting the blind spots baked into the structure, because no investing is ever really ‘passive.
The diversification fallacy
Market cap ETFs operate under a guise of objectivity. They appear well diversified because they often hold hundreds of stocks in the underlying portfolio. Stock-pickers could spend their entire lives sifting through balance sheets and still never replicate the reach of a single index fund bought on a Tuesday lunch break.
However, in many cases, this diversification only appears at the surface level. The ASX is an example of one of the most concentrated developed markets in the world where the financials and materials sector make up around 60% of the ASX 200.
A200 ETF sector exposure. Source: Morningstar data. February 2026.
A market cap weighting amplifies this imbalance by funnelling the largest share of money into the companies in those sectors. On paper you own hundreds of stocks but in practice, your returns are disproportionately driven by a handful of banks and miners.
Furthermore, due to macro forces these sectors often move in tandem, meaning your broad ETF ends up behaving more like a concentrated bet on two cyclical sectors with a long tail of much smaller positions attached. This is great when the cycle is favourable, but when it turns,the entire ETF may dip in unison, even if plenty of the smaller companies elsewhere in the market are doing fine.
Fuel to fire
The ASX 200 has never been more concentrated. And this concentration issue runs deeper than sectors and extends into individual holdings that dominate the index.
The top ten stocks now account for roughly 50% of the index, which means half of every dollar invested in a broad‑market ETF is effectively going into the top ten companies.
By comparison, the S&P 500 had 33 companies make up 50% of the index just before the dot‑com crash in 1999. That isn’t an apples‑to‑apples assessment, however it does highlight the scale of the imbalance we’re seeing domestically.
We don’t just fret about concentration for its own sake. These handful of companies have delivered strong returns that investors have benefitted from over the past few years. But starting valuation is one of the most reliable predictors of long‑term returns.
The chart below shows the Star Rating for each company that dominates the index. A five-star rating means our analysts think the current market price likely represents an excessively pessimistic outlook and that beyond fair risk-adjusted returns are likely over a long timeframe. A one-star rating means our analysts think the market is pricing in an excessively optimistic outlook, limiting upside potential and leaving the investor exposed to capital loss.
As evident above, only one company is in five-star territory, whilst the others are all trading at prices we deem overly optimistic. When you buy into an index that is heavily weighted toward expensive stocks, you’re effectively locking in lower future returns and exposing yourself to deeper drawdowns if sentiment cools.
This doesn’t mean market cap ETFs are inherently bad, it simply reflects a structural feature of the Australian market and therefore a structural feature of any ETF that tracks it. The real issue is when investors automatically conflate the breadth of holdings with the breadth of actual exposure.
Is there another way?
An equal-weighted approach is another common strategy that holds the same constituents but weights them equally, regardless of market capitalisation. In essence, you’re underweighting large caps and overweighting smaller players. This negates the concentration risk (sectors, cyclicality etc) that we see in market cap weighted funds, whilst potentially providing exposure to a higher quality of constituents in the case that returns are muted at the top end.
This seemingly solves the concentration problem, however, comes with its own set of trade-offs. These include higher turnover and transaction costs, more volatility, less tax efficiency and the tendency to lag when mega-caps drive the market. This is the price of spreading exposure more evenly.
This strategy doesn’t just reduce concentration and call it a day. It also changes the shape of the portfolio and those differences introduce what’s known as active risk which is the degree to which an ETF’s exposures deviate from the traditional market cap index.
Take VanEck Australian Equal Weight ETF MVW as an example. By giving every company the same weight, it naturally ends up with less exposure to the giants that dominate the ASX 200 e.g. Financials fall from around 30% of the index to roughly 21% in MVW.
But the flip side is that sectors normally overshadowed in a cap‑weighted index receive a larger allocation. Real estate is a good example with MVW holding about 10% in real estate, compared with roughly 6% in the ASX 200. Whilst you’re no longer hugging the index, it means your returns will likely diverge from the benchmark depending on the relative performance of these sectors.
This isn’t a call for a complete strategy overhaul. Unsurprisingly, you can find academic theory that supports both methods and several alternatives. The reality is that no one knows which approach will work over the next five years, let alone the next twenty.
Whatever index and corresponding ETF you choose, you’re choosing a set of rules that determine what your money leans into and what it ignores. Market cap ETFs aren’t objectively unsafe and equal-weight ETFs aren’t an explicit solution. The most important thing is to avoid being blindsided by risks you never intended to take.
