One of the primary drivers of the boom in ETFs over the last decade is that they provide efficient diversification to the market and various sectors/groups. While that’s the theory, the reality is that a number of the biggest sector ETF’s aren’t all that diversified at all. The chart below shows the weight of the top two holdings in each of the 11 S&P 500 sector ETFs. Would you believe that the two largest holdings in two ETFs account for more than 40% of the entire ETF, while in the ETFs for another two sectors the largest two components account for more than a third of the entire ETF? That’s right, in the Energy sector, the top two holdings (Exxon and Chevron) account for just under 43% of the entire ETF, while Alphabet (GOOGL) and Facebook (FB) account for 41.8% of the new Communications Services sector ETF (XLC). In the Tech sector, Apple (AAPL) and Microsoft (MSFT) account for just under 40% of the XLK ETF.
The table below lists each of the eleven sector ETFs along with their top two holdings. As noted, in the case of companies with dual-listed share classes in the ETF, we include both share classes as one. In the case of three sectors (Communication Services, Consumer Discretionary, and Energy), the top holding accounts for over 20% of the entire ETF. Normally, when you think about diversification, you would picture spreading out your bets across a variety of different companies so that you aren’t too exposed to any one name. However, when one out of every five dollars invested goes to one stock, we aren’t sure how diversified that really is. Now, the purpose of highlighting these top-heavy ETFs is in no way meant to imply that these ETFs are faulty in their construction. In fact, these ETFs do a very good job of tracking the sectors they are intended to track. Instead, it is an illustration of just how top-heavy the major indices have become. Investing in “the market” or a specific sector is increasingly becoming a concentrated bet on a number of large names. Start a two-week free trial to Bespoke Institutional to access our Trend Analyzer tool and track key trends in individual stocks and major ETFs.