Our favourite ETFs – Australian shares

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Our Stockspot portfolios invest in low-fee Exchange Traded Funds (ETFs) across various assets and we are constantly reviewing the investment choices to ensure that our clients have access to the best possible return and diversification opportunities.

Over the coming months, we will be looking in detail across each of the 5 different broad asset classes we currently invest in, discussing why we’ve chosen the ETFs for our portfolios and looking at some of the other options. We start off with a look at Australian shares ETFs.

Why invest in Australian shares

Australian shares (broad market) ETFs make up 27.8% of the total ETF funds listed on the ASX. There are 14 ETFs in this category whose size range from $2 million to $2.8 billion and fees from 0.15% to 0.55%.

Australian shares are a core asset in all of our portfolios, constituting between 15% to 50% of the overall portfolio allocation. This asset allows investors to participate in the long-term growth of the Australian economy and access the potential tax benefits of franking credits.

Since Australian shares are domiciled in Australian dollars they are most relevant to investors who have future liabilities and expenses in Australian dollars. Having the majority of your investments in your home currency reduces the risk that currency fluctuations could impact the ability to cover your future expenses. This is why we have a larger allocation to Australian shares compared to global shares or emerging market shares.

How we select ETFs

When building portfolios we look for ETFs with the following characteristics:

  • Total management fees should be low, typically 0.25% per annum or lower where possible. Low fees are vital for maximising long-term returns as fees can kill your savings and our Fat Cat Funds Report exposed how the majority of actively managed funds underperform the market after fees.

  • The fund should have at least $25m under management so there is a good range of underlying securities and the average daily value of trades should be more than $500,000. This helps to ensure it is easy to get in and out, and reduces the reliance on market-makers to determine pricing.

  • We prefer ETFs with simple structures that don’t rely on derivatives and are exposed to very low or zero counterparty risk. Counterparty risk refers to the chance that an ETF may not track its benchmark due to factors like the creditworthiness of an ETF issuer, or fund solvency (ability to meet hedging cash-flow requirements).

Our selected ETF

We have chosen the Vanguard Australian Shares Fund (VAS) for our portfolios with our second choice being SPDR S&P/ASX 200 Fund (STW).

VAS, with a fee of 0.15% and tracking the S&P ASX/300 Index, offers greater diversification benefits than STW which tracks the S&P/ASX 200 with a fee of 0.29%. It should be noted however that stocks in the 201-300 range only make up about 2% of the index so the difference between these 2 funds is actually quite small.

The Vanguard fund also has a significantly lower expense ratio which has seen it grow considerably faster than SPDR’s fund over the past year. The iShares MSCI Australia 200 Fund (IOZ) which has a 0.19% annual fee has also been seeing strong growth, however its liquidity is lower than VAS and STW.

The Australian share market is dominated by a few large-sized companies – in particular financials, resource companies and Telstra. The top 10 companies account for over 50% of the S&P/ASX200 Index. As a result, investors are exposed to significant industry and single-stock tilts (exposure to a few companies) when investing in broad Australian equity market, with the market concentrated in financials (~49%) and materials (~14%) which increases concentration risks.

The Market Vectors Australian Equal Weight ETF (MVW) tries to solve this issue by giving each stock an equal weighting rather than weighting stocks according to their market size like most ETFs. MVW enjoyed a strong first year of returns, outperforming the traditional size-weighted ETFs. The downside of this ETF is a higher annual fee (0.35%) and lower distribution yield (1.5%) due to less exposure to the big dividend paying stocks like Telstra (TLS) and Commonwealth Bank (CBA). Since equal-weight ETFs have greater exposure to small stocks, they tend to contain more risk which is the main reason they outperform.

Despite some shortcomings, our preference for a core investment in Australian shares is the traditional size-weighted ETF – VAS given their benefits of its size, liquidity, lower fees and providing a truer reflection of the performance of the Australian economy than equal-weight ETFs.
 

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Stockspot is Australia’s fastest growing automated investment service. We can help you build and manage a personalised portfolio tailored to your financial situation and your goals. With Stockspot, there’s no paperwork, no need to be an expert and no hassles.

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Image: Denis Dervisevic via Flickr

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Chris Brycki

Stockspot Founder and CEO

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