Exchange traded funds provide investors with broad market exposure, but investors should still look under the hood or risk finding unwelcome surprises.
FDN’s outperformance is attributed, in part, to its allocation to Amazon (AMZN), which is up 22% this year, and its lack of exposure to Apple (AAPL), which is down 8.0% year-to-date. XLK, on the other hand, has a 14% allocation toward AAPL. FDN has also gotten a boost from Facebook (FB) and Google (GOOG), among other Internet heavyweights.
If an investor is more comfortable with holding an all inclusive technology ETF but is concerned about heavy stock allocations, the Guggenheim S&P 500 Equal Weight Technology ETF (RYT) equally weights holdings, so AAPL makes up about 1.6% of the fund. RYT has gained 26% so far this year. [What an Equal-Weight S&P 500 ETF Brings to the Table]
Investors should understand that most capitalization-weighted ETFs overweight exposure in stocks based on the firm’s market capitalization, so larger companies get a larger weighting. [Understanding ETF Portfolio Indexing]
The overweight characteristic is not limited to tech ETFs. For example, General Electric (GE) is the largest holding in the Industrial Select Sector SPDR (XLI) , with an 11% weighting. On the other hand, investors can use an equal weight methodology to reduce large allocations to one stock, such as the Guggenheim S&P 500 Equal Weight Industrials ETF (RGI) , which allocates less than 2% to GE.
However, investors should also know that a large single stock holding is not necessarily bad since it could help lift an ETF in good years. In the year leading up to September 2012, Apple rallied to its all-time high, which helped XLK rise 30% in, compared to RYT’s 19% gain.
For more information on ETFs, visit our ETF 101 category.
Max Chen contributed to this article.
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Mr. Lydon serves as an independent trustee of certain mutual funds and ETFs that are managed by Guggenheim Investments; however, any opinions or forecasts expressed herein are solely those of Mr. Lydon and not those of Guggenheim Funds, Guggenheim Investments, Guggenheim Specialized Products, LLC or any of their affiliates. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.