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Tech ETF Faces Potential Shake-Up as Nvidia Surpasses Apple
The $67 billion Technology Select Sector SPDR Fund (ticker XLK), one of the world's major tech ETFs, is on the brink of a significant adjustment. Nvidia Corp. has recently surged past Apple Inc. in market value, impacting the fund's asset distribution. For months, XLK has held significantly fewer shares of Nvidia due to diversification rules, even as Nvidia's stock has soared.
Currently, Nvidia accounts for about 6% of XLK’s assets, compared to 21% for the S&P 500 Information Technology Index. This disparity has caused XLK to underperform. If Nvidia maintains its lead over Apple by the end of this week, XLK’s quarterly rebalance may drastically increase Nvidia’s weight in the fund. Such a recalibration could reduce Apple’s share in XLK from 21% to as low as 4.5%, compelling State Street Global Advisors, XLK’s manager, to buy around $10 billion in Nvidia shares while selling approximately $11 billion of Apple shares.
Bloomberg Intelligence's James Seyffart comments that if Nvidia is larger on the key date, the fund managers will have to reallocate per the rules, potentially selling Apple shares. The diversification rules were designed decades ago to protect investors, but in a heavily lopsided market, they are proving challenging.
The impact of these diversification rules, which limit the influence any single stock can have on XLK, shows how momentum in tech giants can clash with regulatory caps. These rules prevent any stock's impact from surpassing defined thresholds, compelling rebalancing to maintain compliance.
A similar issue prompted the Nasdaq 100's overseer to perform a special rebalance last year. The rules require that the top stocks representing roughly 5% or more of a diversified fund cannot total more than 50% of the index. If this occurs, the largest holdings are proportionally reduced. In XLK, the process differs: when there’s a breach, the smallest non-compliant stocks are trimmed first.
Recent quarterly rebalances saw Nvidia’s weight in XLK reduced to 4.5% due to its trailing behind Microsoft Corp. and Apple in valuation, even though it constituted 17% of the regular S&P 500 tech index in March and 11% in December. This disparity occurred despite Nvidia's significant market surge this year, about 145%, driven by the AI boom, causing XLK to lag the S&P 500 tech gauge by 4.5 percentage points this quarter—the most significant gap since 2001.
Chris Harvey of Wells Fargo Securities points out that a rebalance could substantially alter XLK’s profile. Increasing Nvidia’s presence and decreasing Apple’s could pivot the ETF towards a more semiconductor and momentum-oriented focus. This shift might change how investors perceive and trade the fund.
