How to avoid having Big Tech dominate your technology portfolio
sankai
Investing in exchange traded funds theoretically offers the advantage of a diversified approach to a particular sector. However, the structure of the ETF makes a big difference. In many technology ETFs, a few behemoths often dominate, undermining one of the potential benefits of the strategy.
As an example, take the popular Technology Select Sector SPDR Fund ETF (NYSEARCA:XLK) compared to the alternative equal-weighted Invesco S&P 500 Equal Weight Technology ETF (NYSEARCA:RYT). XLK and RYT share the same 69 holdings. Internally, though, the underlying structure of the funds differ significantly.
Within the XLK, more than 50% of the ETF is attached to just three stocks. Specifically, XLK's top three holdings together represent 51.38% of the fund. This includes Apple (AAPL) at 23.93%, Microsoft (MSFT) at 23% and Nvidia (NVDA) at 4.45%.
Meanwhile, RYT equally distributes its portfolio across all 69 names. That means AAPL, MSFT and NVDA only make up a fraction of the fund's composition -- no more than any other three stocks in the ETF.
This can lead to a massive variance in return. In 2023, XLK has jumped 20% while RYT has only gained roughly 6% on the year. This came as the heavyweights in XLK surged. AAPL is +33.5% YTD, while MSFT and NVDA are +26.4% and +87.3%, respectively.
While this concentration has benefited XLK investors in 2023, it also increases the risk that a drop in any of the major holdings will drag down the entire ETF. For instance, in 2022, XLK fell 28% while RYT posted a slightly less steep decline of 25%.
This can also be true of market averages as a whole. Jefferies recently noted that despite the gains recorded for the S&P 500 (SP500) in 2023, the advance has been driven by a relatively thin portion of the index. Only 32% of stocks have outperformed the complete index so far this year.