Despite comparable market values, Nvidia's weight in the SPDR technology sector fund has surpassed Apple's, leading to a costly disparity for shareholders.
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The valuations of Apple, Microsoft, and Nvidia, the three largest U.S. companies by market value, have soared above $3 trillion this year, collectively accounting for over 60% of the S&P 500's information-technology sector. This market dominance has created a challenge for index-tracking funds, as traditional concentration rules limit the combined contribution of the top companies to 50%.
Market Disparity: Nvidia Outperforms Apple in SPDR Tech ETF
The disparity between Apple and Nvidia's weight in the State Street's $70 billion SPDR technology sector fund (XLK) became evident in the third quarter when Apple outperformed Nvidia by 10 percentage points. This discrepancy cost shareholders billions of dollars, highlighting the limitations of passive investing strategies.
To address this issue, S&P Dow Jones Indices modified its methodology, lowering the weights of Apple, Microsoft, and Nvidia proportional to their market cap. This adjustment ensures that the combined weight of these companies remains below 50%. Had the rules not been changed, the fund would have faced a massive swap between Nvidia and Apple shares, further disrupting the portfolio.
Market Disparity: Nvidia Outperforms Apple in SPDR Tech ETF
The SPDR fund's discrepancy demonstrates that passive investing, while typically offering the best return with limited risk, can have drawbacks. The rise of a handful of dominant tech stocks has altered the market landscape, creating unexpected concentration issues.
Federal securities regulations limit the investment of a single stock to 25% of a fund's assets, and the combined weight of companies exceeding 5% cannot exceed 50%. These rules ensure regulated investment companies can pass profits to shareholders tax-free.
Market Disparity: Nvidia Outperforms Apple in SPDR Tech ETF
Nvidia's recent surge in market cap pushed it past Apple in the June rebalance, resulting in a weight increase to 21%. This change prompted index-tracking funds to sell billions of dollars in Apple shares and buy Nvidia stock, a substantial shift that surprised many investors.
Many investors in tech index funds were unaware of the significant weight disparity between the top three companies, causing growing discontent. The revision to the index methodology aimed to address these concerns and maintain compliance with the concentration rules.
Concentration issues have also emerged in the tech-heavy Nasdaq-100 Index, leading to an unscheduled special rebalance in July 2023 to ensure the largest companies did not exceed 50% of the benchmark.
The rise of mega-cap technology stocks has challenged traditional index-fund methodologies, leading to adjustments in the rules governing fund concentration. Investors should be aware of the potential for disparities within passive investment strategies and the ongoing impact of market dynamics on portfolio performance.
