(Bloomberg) — One of the world’s most prominent technology ETFs appears poised for a major rebalancing that will reduce exposure to Nvidia Corp. would increase at the expense of Apple Inc. – which would instantly generate billions of dollars in trading volume.
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Barring an eleventh-hour deviation from index provider S&P Dow Jones Indices’ methodology, State Street Global Advisors is on track to revamp the makeup of its $71 billion Technology Select Sector SPDR Fund (ticker XLK) after the market value of Nvidia closed above Apple. on Friday.
For months, XLK has held far fewer Nvidia shares, even as the AI giant is up 166% so far this year. When the chipmaker finished in third place, it represented roughly 6% of the ETF’s assets, compared to 22% in the S&P 500 Information Technology Index. The ownership cap imposed under the diversification rules has caused XLK to massively underperform this year.
While S&P theoretically reserves the right to make an exception, industry participants say the ETF is on track to be rebalanced when it implements its quarterly rebalancing at the end of June.
On that basis, Apple and Nvidia will unwind their positions in the ETF, with the former’s weighting dropping to 4.5% and the latter rising to above 20%, according to calculations sent by the index provider to three market participants known are on the case.
By one estimate, State Street is about to buy $11 billion of Nvidia stock and dump $12 billion of Apple. That is not unimportant: the expected sales in Apple shares are equal to the average daily trading value over the past three months.
“By our calculation, the flip-flop between Nvidia and Apple will happen,” said Chris Harvey, head of equity strategy at Wells Fargo Securities. “This brings the XLK ETF more closely in line with momentum trading and half-year results. At the margin, it’s more dollars chasing a stock that doesn’t need any extra help.”
An S&P spokesperson declined to comment on possible index changes and referred Bloomberg News to the methodology.
Matt Bartolini, head of SPDR Americas Research at State Street, said XLK will rebalance according to the rules and methodology. The ETF is required to track the S&P benchmark which is designed to stay in line with diversification rules.
The rules “have served investors well,” he said.
S&P has left the door open to making an exception when it announces sector weightings at the end of the month, according to a document sent late last week and seen by Bloomberg News.
The index committee “reserves the right to make exceptions in applying the methodology as necessary,” S&P wrote in a note on the rebalancing in June. “In any scenario where treatment deviates from the general rules set out in this document or additional documents, clients will be notified where possible.”
S&P said it will send clients so-called proforma documents related to sector index rebalancing every day through Friday.
Any last-minute deviation from the public methodology would not be taken well by traders, who tend to take positions in anticipation of possible revisions to these types of index rebalancings. As things get busier, buying stocks that enter major indexes and selling stocks that leave them has become one of the hedge fund world’s most reliable strategies.
Underlying the massive adjustments to the duo’s weightings in the ETF are diversification rules that date back more than 80 years and were designed to protect investors from concentrated bets. Under these rules, the combined representation of the largest companies – which make up roughly 5% or more of a diversified fund – cannot exceed 50%.
Similar restrictions spurred the Nasdaq 100’s regulator last year to conduct a special rebalancing to ensure index-tracking funds remained compliant. When this rule is broken, indexes like the Nasdaq 100 tend to trim the top positions proportionately. XLK’s methodology works differently. If a number of shares do not meet the requirements, the smallest one is cut off.
This unique rule is why Nvidia is vastly underlevered by XLK, putting the fund more than 5 percentage points behind the traditional S&P 500 tech subindex this quarter – the widest spread since 2001.
Now that the semiconductor pioneer has surpassed Apple and Microsoft Corp. in size in recent weeks. has caught up, XLK’s upcoming rebalances have piqued Wall Street interest given the prospect of volatility-inducing weight additions and reductions at some of the world’s most watched tech companies.
“I’m curious to see if they keep the rules the same during the next rebalancing in September,” said James Seyffart, ETF analyst at Bloomberg Intelligence. “If Apple manages to outpace Nvidia or Microsoft on the next rebalancing reference date – which is September 13 – we could have a massive mirror-image rebalancing where Apple is bought for billions and Nvidia or Apple is sold for billions. ”
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