Most exchange traded funds passively track benchmark indices that follow a capitalization-weighted methodology. Consequently, some sector and broad market ETFs lean toward a handful of heavyweight stocks.
Passive ETFs track a basket of stock holdings from a benchmark index. However, in a traditional market-capitalization weighted index, large companies will have a heavier weighting in the index and related ETF.
“Investors holding too great a percentage of assets in one sector or in the stocks of one country could be in for a rude awakening if a market jolt strikes.” according to Morningstar‘s Adam Zoll. “Plus, you may already have exposure to the sector or region through other, more diversified funds in your portfolio, such with as a broad market index fund. But another, more hidden risk, involves ETFs that are highly concentrated in just a handful of stocks.”
While a high concentration in a couple of stocks may bolster an ETF if the large holdings are doing well, the holdings can put a drag on heavily concentrated ETFs during harder times.
According to Morningstar data, the iShares High Dividend ETF (HDV) is the most concentrated non-sector, non-regional ETF, with 62.3% of its total allocations in the top 10 holdings. [ProShares Aristorcrats ETF Tracks Quality S&P 500 Dividend Payers]
HDV’s top holdings include AT&T (NYSE: T) 9.1%, Chevron (CVX) 6.9%, Johnson & Johnson (JNJ) 6.8%, Procter & Gamble Co. (PG) 6.2%, Pfizer (PFE) 6.1%, Verizon Communications (VZ) 5.5%, Philip Morris International (PM) 5.2%, Merck & Co (MRK) 4.9%, Intel Corp. (INTL) 4.3% and Coca-Cola (KO) 4.0%.
The Nasdaq-100 PowerShares QQQ ETF (QQQ) is also a classic example, with its hefty allocation to tech-giant Apple (AAPL). AAPL has also thrown its weight around in other tech-related ETFs, often making up double digit exposure. [Watch Your Apple Exposure in Growth ETFs]
Under QQQ, AAPL is 12.5%, followed by Microsoft (MSFT) 7.8%, Google (GOOG) 6.6%, Amazon (AMZN) 3.9%, Cisco (CSCO) 3.4%, Qualcomm (QCOM) 3.2%, Intel Corp (INTC) 3.2%, Comcast (CMCSA) 2.7%, Gilead Sciences (GILD) 2.6% and Facebook (GOOG) 2.4%.
For more information on ETF indexing methodologies, visit our indexing 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. 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.