One of the tech sector's largest exchange-traded funds is quadrupling its holdings of the market's hottest tech stocks, and whether investors really benefit will depend on which of the industry's three giants — Apple, Microsoft and Nvidia — performs the best in the coming months.
At issue is the makeup of the $70 billion Technology Select Sector SPDR ETF, one of the most popular choices for investors looking for one-stop exposure to big technology stocks. The fund has returned 17% so far this year, well above the market but still trailing the return of big tech stocks by nearly 7%, according to Morningstar.
As it happens, the fund has fallen victim to Internal Revenue Service regulations designed to prevent mutual funds from becoming too concentrated in a few stocks. One rule states that no individual position worth more than 5% of a fund's assets can account for more than 50% of its holdings.
That's problematic, given the enormous market capitalizations of today's top tech companies. The fund has 22% of its assets invested in Microsoft and Apple, which are worth just under $3.3 trillion each. But Nvidia, which is just behind the other two with a market capitalization of $3.15 trillion, accounts for just 5.7% of the fund.
This will ensure that the fund does not exceed the 50% concentration threshold.
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That could change later this month, according to a recent report from Ned Davis Research: The Tech Select Sector SPDR is set to rebalance its holdings on June 21 based on Friday's closing stock prices.
If Nvidia's market cap were higher than either Microsoft or Apple, it could unseat them as one of the fund's top two stocks with a 20% or higher allocation. The change would bring the allocation of the stock it replaces to well below 10%, similar to the chipmaker's current position.
“After all, if NVIDIA ends this week with a larger market cap than Apple or Microsoft, the ETF's underweight would shift from NVIDIA to the mega-caps with the smallest market caps,” the Ned Davis note said.
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If all this plays out, will investors stand to gain? That depends on which of these three stocks perform best going forward and, of course, how concentrated the market remains.
“It's unusual for these three stocks to be this big,” said Matt Bartolini, managing director of SPDR ETFs, but he added that “these are rules that sector investors have to follow.”
Whatever happens on Friday, the bigger question remains: Given the mismatch between sector funds' holdings and the actual size of the tech giants, are they doing their job of reflecting the performance of the industry?
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The Vanguard Information Technology ETF, a rival to the Select Sector SPDR, has a larger allocation to Nvidia (about 12%) but that comes at the cost of underallocation to Apple and Microsoft.
Rob Anderson, U.S. sector strategist at Ned Davis Research, says the best approach may be to simply make do. Sector ETFs, despite their flaws, are far more convenient for most people than trying to track a sector by buying individual stocks. And while performance may lag in the short term, the difference often evens out over time, Anderson adds.
Over the past 15 years, the Select Sector SPDR has returned an average of 19.9% ​​annually, compared with tech stocks' 20.3%, according to Morningstar.
Email Ian Salisbury at ian.salisbury@barrons.com
