BHP weighting to jump leaving ASX ETFs overloaded
The unification of the company's dual-listed structure could make ETF investing in Australia even more exposed to sector-concentration risk.
BHP will become Australia’s largest company after announcing the unification of its corporate structure to a single primary listing on the ASX. However, its greater weight in the S&P/ASX 200 could push ETFs tracking the index to become even more concentrated in resource shares.
Research from Morgan Stanley, financial adviser to Woodside on the merger deal shows that if BHP were to incorporate all its shares on the ASX, BHP's index weight within the S&P/ASX 200 would jump to 11.7 per cent from 7.2 per cent. The miner would surpass the Commonwealth Bank of Australia as Australia’s largest company.
The materials sector weight would increase to 24.1 per cent of the S&P/ASX 200, still below the financials sector index weight of 28.3 per cent.
Brett Evans, managing director of Atlas Wealth Management, said the changes to BHP’s listing would make ETF investing in the Australian market even more exposed to concentration risk.
Investors in an ETF tracking the S&P/ASX 200 would be vulnerable to a downturn in the finance or mining sector, due to the fact that these two sectors would comprise 52.4 per cent of the ASX200 index and would govern over half of the returns from the index.
“If we look at the financials sector in Australia it has underperformed the ASX200 index over the last three years (3.85 per cent return for the financial sector versus 18.24 per cent for the ASX200 to August 19)," Evans says.
“Should we see a downturn in the materials sector, which is highly reliant on China, then we could see the ASX200 sector as a whole underperform both developed and developing markets."
Woodside Petroleum and BHP entered into a deal to combine their respective oil and gas portfolios to create a global top 10 independent energy company. At the same time, BHP plans to unify its corporate structure into one primary listing on the Australian Securities Exchange (ASX) from its current structure, with dual listings on the ASX and London Stock Exchange. The unification requires approval from BHP shareholders and regulators and is slated for the first half of 2022.
Around 15 per cent of BHP’s current ownership is held by index funds. Several ETFs track the ASX 200, including the SPDR S&P/ASX 200 Fund, one of the largest ETFs in Australia, and the iShares Core S&P/ASX 200 ETF.
State Street Global Advisors senior portfolio strategist, Yvette Murphy said the S&P/ASX 200 index has had large contributions from financials and resources, hence the need for investors to invest in offshore markets as well.
“It is not unusual for a single constituent of the index to account for more than 10 per cent. Having said that, resources now takes up about 20 per cent of the index, compared to close to 35 per cent 10 years ago,” she says.
“Sector biases in local indexes are common and are why a growing number of investors are choosing a global ETF or a selection of ETFs for their portfolios.”
Australia’s largest ETF, the Vanguard Australian Shares Index ETF tracks the S&P/ASX 300. Duncan Burns, head of equity income group at Vanguard Australia said the ASX 200 or ASX 300 still offers investors more diversification benefits than picking individual shares. However, solely investing in the ASX does leave investors exposed to a home bias risk.
“With Australia representing only around 2 per cent of the total world share market, we urge investors to consider the benefits of investing in other asset classes such as international or emerging market equities," he says.
"This would further spread risk and return across a variety of sectors, and in bonds to balance out the volatility in a portfolio.”
Deal boost BHP’s outlook
As for BHP itself, Mathew Hodge, Morningstar resources analyst, says the merger looks beneficial from BHP's perspective.
“We think BHP shareholders would not be materially worse off and we'd expect the deal to go ahead,” said Hodge, who has made no change to his $41 per share fair value estimate for BHP. Shares are trading at about a 20 per cent premium to that fair value estimate.
“This reflects high prices for copper and iron ore which we think are unlikely to sustain,” he says.
Other analysts have upgraded price targets, believing the merger is good for BHP.
“We like the direction that BHP is heading under the stewardship of Chairman, Ken Mackenzie, and chief executive Mike Henry,” says a research note from Shaw & Partners.
“The continued portfolio streamlining, the clunky corporate structure unbundling and the pivot to future facing commodities (potash) looks sensible, strategic and logical to us,” the note said.
Shaw & Partners has a price target of $56 on BHP, compared to its current price of around $45 and prefers BHP over its peer, Rio Tinto.
Separately, Morgans has raised its target price on BHP to $45.90 from A$45.50 and sees a buying opportunity given expected short-term downward share price pressure once BHP goes ex-dividend which it says is “an opportunity for more active investors to consider taking partial profits.”
Square listing on the cards
Separately, Square plans to list securities on the Australian Securities Exchange after the Afterpay board recommended a $39 billion takeover deal.
“We believe the transaction has a high chance of succeeding," says Morningstar analyst Shaun Ler.
"The implied offer is 68 per cent above our valuation for Afterpay on a stand-alone basis--a generous premium, in our view."
However, Ler says the impact on the S&P/ASX 200 is not yet known and will depend on the final makeup of the takeover deal and the number of Square securities listed on the ASX. However, the market capitalisation of those securities could mimic Afterpay’s current market cap, says Ler, which means the combined entity could have the same weight within the index.