Don’t accidentally overweight regions and sectors

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Not infrequently I see ETF portfolios which include the following funds:
iShares MSCI World
iShares STOXX Europe 600
iShares S&P 500

The problem of this portfolio is that it contains different ETFs which hold the same assets. These funds have the following investment strategy:

  • iShares MSCI World – invests in companies of 23 developed countries worldwide (e.g. Europe, Canada, US, etc).
source: iShares ETF FactSheet
  • iShares STOXX Europe 600 – invests in 600 companies in developed European countries.
source: iShares ETF FactSheet
  • iShares S&P 500 – invest in 500 of the largest companies in the US.
source: iShares ETF FactSheet

As the images above show the countries invested by the iShares S&P 500 fund and the iShares STOXX 600 fund are a subset of the countries invested by the iShares MSCI World fund.

Additionally, if we look at the “Holdings” tab for the fund’s iShares page (e.g. iShares MSCI World, iShares S&P 500, iShares STOXX 600 Europe) we will notice that there is a significant overlap in the actual companies invested by the funds. Only 8 of the assets of the iShares S&P 500 (out of a total of 511) are not present in the iShares MSCI World fund. Only 185 of the assets of the iShares STOXX 600 Europe (out of a total of 613) are not present in the iShares MSCI World.

This portfolio which combines the iShares MSCI World, the iShares S&P 500 and the iShares STOXX 600 is effectively increasing the exposure to US and European stocks. This process of overweighting a particular region or sector is called tilting.

Diversification is about investing in different assets in order to mitigate risk. In this scenario, buying these different overlapping ETFs does not provide you with additional diversification. When buying multiple ETFs you should pay attention to their holdings and investment strategy to avoid accidentally overweighting the allocation to certain countries/companies/sectors.

Some people decide to intentionally tilt their portfolio to particular regions – home bias being a notable example – and that is OK. What this post cautions against is doing that without realizing it.

An earlier post I wrote discusses this and other aspects to consider when analyzing your portfolio.