You may think you’re a passive investor - but you’re not.

The issue with investing in broad market index products is that you are anything but a passive investor. Owning the market does not mean that you own everything equally. When you look closely, many of the most popular ETFs in Australia embed a set of structural bets that can materially shape outcomes over time.

Although there’s no active manager sitting there and making these decisions, you’re still taking active bets. It is not the result of poor product design. It is simply a consequence of how indices are built.

Mark and Shani run through these exposures in common passive ETFs, and alternatives for investors that need it.

Read the full article here.

For investors that have passive investments in their portfolio, we have more resources from Morningstar:

Build a lazy ETF portfolio in 2026: This article from James runs through how to build a portfolio that has a no-fuss investment strategy.

Young & Invested: The illusion of ETF returns: Sim looks at a Morningstar study that explores the persistence of fund returns, and helps investors decode what is important.

Is there still a case for active management? Our Active/Passive Barometer reveals the winners in fund performance.

Where active managers outperform their passive peers. Our latest Active/Passive Barometer report.

You can find the transcript below:

Mark Lamonica: 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.

Shani Jayamanne: And before we begin, we just want to give a quick shout out to the Australian Shareholders Association or the ASA. The ASA has a long history of advocating for individual investors and making sure that shareholders are educated, informed and they are represented in the market. And that mission really aligns with what we are trying to do and our goal with helping people make better financial decisions over time.

Lamonica: Plus, the ASA has really good taste because they have selected you as an education partner.

Jayamanne: Thanks Mark.

Lamonica: So that’s exciting. But Shani and I regularly attend their chapter meetings. So, they have chapter meetings in different communities around Australia. And I think we both always enjoy that because we learn something. It’s a group of really engaged investors, really knowledgeable investors. And these chapter meetings are an opportunity for people to share their ideas, share the different things they’re worried about or excited about in terms of the market. And they run in-person events. They run a of couple different Australia-wide conferences every year. They have webinars. They have a magazine that they publish called Equity, which you frequently contribute to. So, it is a really great place and community for investors to learn more and get support from their fellow investors.

Jayamanne: And I think when I think about this podcast, Mark, we get so much value out of it. I do. I hope you do too because we get to discuss and debate ideas before we do present it to the listeners. It really gives us a chance to reaffirm our positions or question the approaches that we do have. And the ASA offers investors the same opportunity to do that. So, if you are looking for a credible education and a community of thoughtful investors, the ASA is well worth exploring.

Lamonica: So, there’s a link in the show notes. They have a special offer for listeners to Investing Compass 50% off the annual dues, which is great.

Jayamanne: It is great.

Lamonica: So, take advantage of that. And now we’re going to get into our topic for the day, Shani.

Jayamanne: All right. So, we know that the financial services industry loves a label, Mark.

Lamonica: That’s true. There’s passive investors and active investors and growth investors and income investors. And I think particularly the industry kind of encourages you to declare that you are one of these types of investors. And of course, many investment managers advocate for one path, because that’s of course what they’re selling. And they try to make it seem like there is a right answer, which means of course, the other approaches to investing are not right.

Jayamanne: And you know that we’ve reluctantly fallen into these camps as well, Mark, after the five years of doing this podcast.

Lamonica: I mean, I guess so. I’m an income investor. If you’re going to call me anything, I guess you’d call me that.

Jayamanne: Did you have any other labels for yourself?

Lamonica: I mean, you label me all sorts of things. Old – Shani was talking about dementia before this. And if I was going to be able to remember what I was supposed to say today, but lots of labels. What about you, Shani? What label would you put on yourself as an investor?

Jayamanne: Look, I think reluctantly, I would say passive investing camp. I don’t invest in direct equities. And instead, I favor mostly broad market index ETFs. And this is the same strategy as many investors who are not hobbyists and see investing as a compulsory exercise to build and maintain wealth.

Lamonica: But I think the interesting thing about passive investing is it really isn’t that passive. So, that’s what we’re going to talk about in this episode, Shani. So, the issue with investing in broad market products like Shani does is there are of course concentrations and tilts, which means that you are making bets – even if you’re not choosing them, you are making bets in certain places. So, owning the market does not mean that you own everything equally.

Jayamanne: That’s right, Mark. And when you look closely at a lot of the most popular ETFs in Australia, there’s this embedded set of structural bets that can materially shape your outcomes over time.

Lamonica: And we want to be clear here that we’re not saying that there’s an active manager sitting there and making these decisions. And it’s not the result of poor product design, simply just a consequence of how an index is built.

Jayamanne: And our job as investors is to have a proper and comprehensive understanding of what you’re investing in. It’s to understand these hidden bets and the way that they influence the behavior of our investments and how we behave in turn with the outcomes that we do get.

Lamonica: So, we’re going to run through some of these bets that so-called passive investors are making. And we’ll start with the first one. And there’s some interesting stuff going on with this right now. But the first one that the biggest companies, the bigger companies are a larger part of one of these indexes and therefore your portfolio.

Jayamanne: So, most core equity ETFs are market capitalization weighted. And that means that the larger a company’s market value, the larger its weight in the index. So, for example, the S&P 500 ETF with the ticker symbol IVV tracks the top 500 companies in the US. And IVV has 34% of assets in the top 10 holdings, which is pretty concentrated considering that there’s 490 other companies in the investment.

Lamonica: And that’s looking at a very specific US-centered ETF, but you’re getting similar exposure if you invest in global passive ETFs. So, we can look at Betashares’ Global Shares ETF with the ticker BGBL, 29% of the assets are in the top 10 holdings and just under 73% are in one country, which you guessed it is the US.

Jayamanne: And the largest US technology company is now account for a historically high share of global equities indices. So, tech companies do dominate BGBL as well. They make up over 30% of the assets. So, if Apple, Microsoft, NVIDIA, Alphabet and Amazon perform well, your portfolio will benefit disproportionately. But if they struggle, that concentration will offer less protection than you would expect when you’re investing in what you think is a diversified ETF.

Lamonica: Now, you’ve written an article on this, and there’s a lot of data in there on the underlying holdings. So, of course, people should go and look at that. We’ll put that link to the article in the episode notes. But when you look at the top holdings of the iShares S&P 500 ETF, which is of course focused on the US, and you look at the Betashares’ Global Shares ETF, which is global, there isn’t really any difference between any of them with those top holdings.

Jayamanne: Okay, and let’s turn to home. The picture really doesn’t look much better when we look at the ASX 200. So, 44% of assets are in the top 10 holdings. And when we look at the top two holdings, Commonwealth Bank and BHP, they alone make up 17% of the index.

So, from an industry perspective, it’s no secret that the top 200 stocks in Australia are largely concentrated in two industries, financial services at 32% and basic materials at just under 22%. And that was at the time that I did write the article.

Lamonica: And some things have been happening which we should talk about. And I think it illustrates not that this is a risk to investors, but just why you should be cognizant of what’s going on. So, the first thing is, and we’ll take the US and Australia. So, Australia has actually gotten – this year in 2026 has gotten more concentrated. So, the miners have done well, the banks have done pretty well. So, you, kind of, take the big four, Rio, BHP, throw in Macquarie, there’s been more concentration in those shares. So actually, the Australian index now, the ASX 200 is up to 49% in the top 10.

And then interestingly enough, in the US, the exact opposite has happened. There’s obviously been some concerns about AI and potential AI bubble. And so, what you’re seeing is you’re seeing those giant tech shares sell off and the rest of the index is actually doing decently. So, I think this year, the S&P 500 is underperforming an equal-weighted S&P 500. So, the non-tech shares, those non-giant shares are doing well. So, it is just something that’s important for investors to remember. And I think that why is because you make this assumption that if you’re investing in an ETF that tracks a broad market index, is you’re making sort of a neutral, sensible decision. But it does mean that your portfolio is obviously allocating more capital to these large shares and how they do is going to have a large influence over how you do by holding the ETF.

Jayamanne: And again, we want to reiterate that we’re not saying that this is the flaw. This is just how indexes are designed. Market capitalization weighting assumes that price is the best signal of value and future return. And this is just the bet that you’re making as an investor. You’re betting that today’s winners will continue winning.

So, what’s the alternative? If you believe that this concentration risk doesn’t align with the goals of your portfolio, you do have the choice of equal-weighted ETFs, as Mark has mentioned. These ETFs split funds equally between the holdings. And one example is the VanEck Australian Equal Weight ETF, MVW. So instead of that 44% or 49% of assets in the top 10 holdings, it’s 14%. The exposure to each sector is also tempered compared to the market cap-based index. And Mark, this is how you get your broad market Aussie equity exposure. Do you want to talk about your choice?

Lamonica: I will. I actually bought more of this VanEck Equal Weighted Index last week. It’s late February, just so people know when we’re recording this. But the interesting thing is obviously this year, because the giant companies in Australia have done better, the ASX 200 market capitalization weighted ETFs have done better. But I think over the long haul for me and for my goals, that this VanEck Equal Weighted product, the MVW ticker, is more aligned with what I’m trying to achieve. And really, that’s because that label I put on myself as an income investor, that I’m looking at dividend growth, and I think the prospects for dividend growth are better outside of those giant companies in Australia. So, this isn’t completely about diversification. I’m just looking at the concentration, then looking at the individual characteristics of those companies it’s concentrating on and what I care about, which is dividend growth, and I think there’s potentially a better opportunity elsewhere.

So, I wouldn’t call this a directional bet on the market. I think it’s just focusing on what matters to me and ignoring what doesn’t. And I’m comfortable there over the long term that this is the best approach for me to try to achieve my goals.

Jayamanne: All right. So why don’t we move on to the second bet? And that is growth-dominated portfolios. And many investors like to consider themselves growth investors, something being a value investor is more sensible and measured. And these labels are really just referring to the characteristics of the investments that you’re looking at. So, if you’re investing in ETFs that follow that market cap-weighted index, and particularly for the US market, these investments tend to tilt towards growth stocks during long bull markets. And this is the environment that we’ve been in.

Lamonica: Exactly. And I think many investors once again think that they are neutral, taking a neutral stance between these two different investment styles because they’re not holding a dedicated growth or value fund or ETF. But just because there isn’t a label doesn’t mean that you’re necessarily neutral. So, you really do need to look at that underlying exposure, which of course changes over time. And what we want investors to be aware of is that if growth stocks fall out of favor, the experience of holding a building block ETF is going to be very different than potentially what you’re accustomed to.

Jayamanne: And then there’s bet three, and that’s home bias. Most investors, including those outside of Australia have home bias. Aussie investors overwhelmingly favor Australian equities in their core holdings. And there are several reasons for this, including franking credits and familiarity with local companies and ease of access as well. And Mark has written about the value of franking credits before, and it really does add to the total return of the investment. So, it’s no surprise that there’s large tilt towards this exposure.

Lamonica: And what we all need to recognize is that if we look at overall markets globally, the Australian market only makes up about 2% of that total global market. And of course, as Shani said earlier, that 2% is very heavily concentrated in two sectors. So really you’re betting on two main scenarios playing out. So, the first is continued profitability and growth of the Aussie banks and the sustained future growth for the commodities that are, of course, produced by the miners here. And these two factors will heavily impact the performance of your portfolio. And a portfolio that feels diversified because it holds the whole Aussie market may actually just be exposed to very, very narrow outcomes. So, something to always keep in mind.

Jayamanne: All right. So, there’s bet four. The index provider decides what the market is and how you invest in it. And full disclosure here, we’re talking about this with Morningstar being one of the biggest index providers in the world. So, indices are constructed by companies like us and decisions about which companies are included, what would cause a company to be added or removed, and how often rebalancing occurs will shape your investment outcomes.

Lamonica: We’ll go through an example. We’ll take a broad global market index. So, some companies may be excluded and others may be included based on the location of their listing, instead of where that company makes a bulk of their revenue. And this is why it’s so important to pay attention to the index methodology. So, you’re able to find that on the ETF provider’s website or Shani’s favorite thing, the PDS, the product disclosure statement, she reads that in her spare time. And we’ve told the story a couple of times. So, there is an ETF, an iShares ETF. IWLD is the ticker. And the basic story is that iShares owner BlackRock changed the index that several of their ETFs tracked in 2022. And what they were doing was, they were adding an ESG tilt to the indexes. So, one of their most popular ETFs was impacted. That was what I referred to earlier, IWLD, that’s the iShares Core MSCI World ex-Australia ETF. And it turned into the MSCI World ex-Australia ESG ETF. So, obviously only three letters different, but…

Jayamanne: A different index and a different investment.

Lamonica: An important change.

Jayamanne: It’s a pretty alarming decision as an investor. Previous investors weren’t given a choice about whether they wanted to track an ESG index. And regardless, this global index made a purposeful decision to exclude and include companies based on ESG factors. And this may be what you’re looking for, but it’s important to understand what the mandate of your potential investment is. And checking the underlying holdings against the methodology is a mandatory step for ETF investors.

Lamonica: Okay. As the author of this article, Shani, why does any of this matter?

Jayamanne: I mean, investing in investments, tracking market cap-weighted indices has worked out for the most part over the past decade. And large companies have outperformed smaller companies, growth has outshone value within the US do really well, especially across, if you look at the majority of other global markets. But what we don’t want this to be is to imply to investors that it is reinforcing the idea that passive investing is foolproof and throwing money at the market and watch it grow. And the risk is not that large companies will go bankrupt and you lose all your money. The risk is that you don’t have a proper understanding of what you’re investing in and assume that your Midas touch will persist indefinitely. And we have to realize that a change in markets is bound to happen. And investors should understand their exposure to mentally prepare for volatility and understand why a portfolio will perform a certain way under different market conditions. So, Mark, what can investors do?

Lamonica: Well, I mean, first of all, obviously, we do not encourage people to completely change their portfolio after they’ve listened to one podcast. But we do think that there’s a few things that you can do. And the first is really getting to know your portfolio a little bit better, and looking under the hood, spending some time understanding what you’re invested in and how those investments connect to your financial goals. So, once you understand that exposure you have to sectors and regions and styles, you’ll be a better-informed investor. And we think that that will help you be able to navigate different things that are happening in the market. So, they may be boring, they may be Shani’s favorite thing to do, but the PDS can be your best friend, which is always nice, Shani, right? Having a best friend, especially one that’s a PDS. But go through that data, understand those exposures. And if you want to look at your ETF through Morningstar, you can go to the investment page and click on the portfolio tab. And it can show you what’s actually inside of that ETF.

Jayamanne: And the second tip is to be intentional about your tilts. Core satellite is a popular investment strategy, but a lot of investors just end up doubling down on the same exposure as their core holdings. And then there’s diversifying across exposure and not products. So, holding five ETFs doesn’t mean you’re diversified if they all hold the same exposure.

Lamonica: And then the last step is acceptance, Shani, which I think you took from AA.

Jayamanne: Yes.

Lamonica: Now that you have attended AA, to be fair. But I think it’s just all of us just accepting that our portfolios express a view. And that’s not a bad thing. So, no portfolio is neutral, even if you built it entirely using passive funds or ETFs. So, understand why you’ve designed your portfolio in a particular way and make sure it aligns to what you’re trying to achieve as an investor.

Jayamanne: I think just to close this up, I think core ETFs are a powerful tool to build your portfolio. I’m an advocate if it aligns with what you’re trying to achieve, they’re transparent and they’re low cost and accessible. So, they’re attractive to a lot of investors, but passive investments still require active decisions. Understand what you’re invested in and why. And this will mean that you’re making more informed decisions and understand why your portfolio behaves the way it does through the market cycle.

Lamonica: Okay, great. So, anyone who is interested in more information on this topic, Shani’s article is linked in the episode notes. I think it’s a great article, but I’m biased maybe. And also, the ASA discount is in there. So, to save 15% on an ASA membership, just join up.

Invest Your Way

A message from Mark and Shani

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