The ETF trap: When more funds don’t mean more diversification

In fitness, variety only works if it serves a purpose. A cyclist doesn’t reach peak performance by riding alone; they need strength training and mobility work to avoid becoming imbalanced.

Investing is no different.

With the rise of ETFs, brokers and reporting tools have reportedly noticed that investors are building portfolios that appear diversified on the surface, but a closer look often reveals the same exposures repeated under different labels.

Just as doing leg day every day won’t build a balanced physique, a portfolio filled with overlapping ETFs can hinder performance, create the illusion of diversification, and add unnecessary cost.

The great mirror: ASX 200 vs ASX 300

A classic example of portfolio overlap is holding both an ASX 200 and an ASX 300 ETF.

We crunched the data on two popular choices - the Betashares Australia 200 ETF (ASX: A200), which mimics the ASX 200, and the ASX 300 tracker, Vanguard Australian Shares Index ETF (ASX: VAS).

Surely VAS is meaningfully different given it holds an extra 100 companies, right?

Because both indices are market-cap weighted - meaning they allocate based on company size - the similarities are far more pronounced than most investors would expect.

For a start, the top 12 holdings are identical, with only minor differences in weighting as the ASX 300 accommodates more companies.

In fact, let’s get into the weeds for a moment:

In practical terms, around 97% of what you hold in the ASX 200 is contained within the ASX 300.

Unsurprisingly, performance reflects this. Over the past decade, the ASX 200 has delivered total returns of 9.43% per annum, while this figure is 9.39% for the ASX 300, according to S&P data. Any differences in realised returns tend to come down to fees and implementation rather than meaningful differences in exposure.

The iShares S&P/ASX 200 ETF (ASX: IOZ), State Street SPDR 200 ETF (ASX: STW), and the newer Global X Australia 300 ETF (ASX: 300) are other core options for broad Australian market exposure. The same principle applies across other asset classes.

Which brings us to the key point: it’s worth questioning whether you need multiple ETFs doing effectively the same job.

These funds are all relatively vanilla, and in my view, the key differentiator for simple core strategies comes down to fees - and, where relevant, dividend frequency for investors seeking regular cash flow.

The cost of complexity

Overlapping ETFs are certainly a mistake I made early in my investing journey. They’re not a deal breaker - at the end of the day, you’re still getting meaningful market exposure, and that’s what matters most for long-term wealth creation.

But if you’re aiming for peak performance and simplicity, there are a few lessons I’ve learned about when overlap becomes a burden.

First, there is the direct cost. Holding multiple funds that provide the same exposure means paying multiple brokerage fees - particularly if you dollar-cost average (DCA) into several funds regularly - and, in some cases, higher aggregate management costs.

Second, the administrative burden. Investors must manage multiple CHESS statements, track separate cost bases, and reconcile additional tax reporting. It becomes an irritant during tax time.

Third, increased decision-making friction. During periods of market volatility, speed is of the essence. The more funds you hold, the more you have to think about in terms of what to buy and sell, particularly if you're looking to capitalise on market dips.

Where it makes sense

There are, however, situations where overlapping exposures make sense.

Some investors separate their long-term holdings from their trading positions using similar ETFs. One fund - such as VAS - becomes the core, long-term allocation where dividends are reinvested, while another, like IOZ, is used to express shorter-term views on the same asset class.

This can make it easier to manage capital gains and avoid contaminating the cost base of long-term holdings with trading activity.

Another common scenario is where you already hold a large position in a higher-cost fund and are considering switching to a cheaper alternative. While the fee savings can be appealing, doing so may trigger a capital gains tax (CGT) event. It’s important to weigh whether the tax cost is worth the benefit.

Illustrative example: Building complimentary exposures

As an illustrative example, take a broad market ETF like A200 paired with a high-income strategy such as the Betashares S&P Australian Shares High Yield ETF (ASX: HYLD) for the Australian shares component of a portfolio.

While there is some overlap in underlying holdings, the construction is fundamentally different. HYLD weights companies by dividend yield and is designed to generate monthly income, while A200 is market-cap weighted and designed to track the broad index.

Then add a sector tilt with the Betashares S&P/ASX Australian Technology ETF (ASX: ATEC), which represents roughly ~3% of A200 and has zero overlap with HYLD. 

Together, they complement each other by adding a growth, income, and diversification tilt to a portfolio.

Below is a comparison of the top five holdings in each strategy, highlighting the significant differences at the top end of each fund.

Auditing your overlap

So how do you actually assess overlap in your portfolio?

Unfortunately, in Australia, we’re still a step behind. There aren’t many comprehensive, easy-to-use tools for ASX-listed ETFs - unlike in the US, where you can plug in a few tickers and get a full breakdown instantly across multiple funds.

There are some workarounds. One example is ETF Compare, a tool built by an Australian finance blogger that allows you to compare up to two ETFs from major providers. It’s simple and appears to work well.

Beyond that, you’ll need to roll up your sleeves - and this is where AI can genuinely help.

Most ETF issuers publish their full holdings daily, typically as an Excel file. Download the latest holdings for each fund you own, upload them into an AI tool like Gemini, and prompt it with something like:

“Compare the holdings of [Fund A], [Fund B], [Fund C]. Calculate the total portfolio overlap (%) and list the top 10 shared stocks and their weights in each fund.”

From there, you’ll quickly get a clear picture of where your exposures are duplicating - and where you might be over-concentrated.

Happy investing!