New ETFs Bypass Concentration Limits to Boost Exposure to Tech Giants
A wave of new U.S. exchange-traded funds bypasses traditional diversification limits to provide heavier exposure to tech giants like Nvidia, Apple, and Microsoft, raising potential volatility risks for investors.
Investors have long worried that the U.S. stock market is overly concentrated in a handful of massive tech giants like Nvidia, Apple, and Microsoft. However, a wave of new exchange-traded funds (ETFs) is challenging traditional regulatory limits to provide even heavier exposure to these dominant companies.
Bypassing Regulatory Limits
Under U.S. federal tax rules and securities regulations, traditional ETFs and mutual funds face strict diversification limits. A fund generally cannot invest more than 25% of its assets in a single company, and holdings exceeding 5% cannot collectively make up more than 50% of the fund's total value. When market giants grew massively—with Apple and Microsoft each reaching 22% of the S&P Dow Jones technology index in early 2024—index providers had to artificially cap weights, such as limiting Nvidia to 5%.
To circumvent these restrictions, several fund managers have launched new ETFs that exploit a regulatory loophole: investing a large portion of their assets into another ETF, which is exempt from concentration caps. For instance, State Street launched the SPDR S&P 500 Technology Market Sector ETF, trading under the ticker XLKM, which invests 66% of its assets in the traditional XLK fund. While XLKM directly holds just three stocks exceeding the 5% threshold, its indirect holdings mean that roughly 55% of the new fund is ultimately concentrated in Nvidia, Apple, and Microsoft.
Similarly, VanEck introduced its TruSector ETF lineup covering all 11 S&P 500 sectors, utilizing sector-specific ETFs to amplify exposure to market leaders like ExxonMobil and Chevron in the energy sector.
Market Risks and Investor Psychology
These highly concentrated funds are designed to closely track industry benchmarks while reflecting true market weightings without rigid regulatory distortions. Matthew Bartolini of State Street Global Advisors noted that the structure accurately mirrors sector weights. Nevertheless, these instruments will likely experience amplified volatility, outperforming during bull markets and lagging during downturns.
Recent pullbacks in tech stocks, driven by growing skepticism surrounding artificial intelligence returns, highlight the risks. Michael Cohick of VanEck emphasized that these specialized products are not standalone investment solutions. History warns that chasing concentrated momentum can lead to severe losses, making broad diversification or exploring out-of-favor sectors a prudent alternative for most retail investors.
