One of the well-known benefits of investing in ETFs is diversification. However, with benchmark indexes reaching record levels of concentration, broad-based ETFs may not be as well diversified as investors expect.
Concentration in the top 10 S&P 500 stocks notched a new record high of earlier this month, reaching 26.8%. Meanwhile, the benchmark index marched to another all-time high Monday (intraday), on a price return basis.
“One of the benefits of investing in ETFs is diversification,” Todd Rosenbluth, head of research at VettaFi, said. “Rather than concentrating on just a handful of stocks to continue to lead the market higher, investors spread the risk around through several dozen. Stocks that climb sharply higher in one period can quickly fall in value, leading to losses”.
Concentrated leadership can last as long as the broad market is in an uptrend. Lately, however, there have been non-confirmations and divergences, according to Ned Davis, Senior Advisor at Ned Davis Research.
Looking at recent flow data, investors may have more exposure to the top 10 largest companies than they realize.
Year to date through July 15, the top equity ETFs by net flows include the Vanguard S&P 500 ETF (VOO ), the iShares Core S&P 500 ETF (IVV ), the Invesco QQQ Trust (QQQ ), the Vanguard Total Stock Market ETF (VTI ), and the SPDR Portfolio S&P 500 ETF (SPLG ).
The five funds have raked in a combined $129 billion in year-to-date net flows. Notably, this is nearly one-third of all ETF flows during the first half ($413 billion). The top fund, VOO, had its greatest six-month tally on record.
At a high level, these funds are all supposed to offer exposure to the broader U.S. market. However, this exposure doesn’t come without significant concentration.
Looking at Concentration for the Top 5 Broad-Based ETFs
As their names suggest, VOO, IVV, and SPLG each provide access to the S&P 500. Importantly, 36% of VOO, IVV, and SPLG by weight in top 10 names. With roughly 60% of assets in the top 50 names, that means the remaining 450 constituents make up just 40% of the fund by weight.
Meanwhile, QQQ tracks the Nasdaq-100 Index. The Nasdaq is also intended to offer access to large-cap U.S. equities, comprising the 100 largest non-financial companies listed on the Nasdaq exchange. While it’s understood as being growthier and a bit more top heavy than the S&P 500, over 50% of QQQ by weight is currently in top 10 names.
Finally, VTI’s underlying index comprised of 100% of the investable U.S. stock market. This includes large-, mid-, small-, and micro-cap stocks traded on the NYSE and Nasdaq.
Despite its exposure to the entire U.S. stock market, nearly 30% of VTI by weight is in the top 10 names.
Why Concentration Matters
Concentration, particularly when leaned into deliberately, isn’t necessarily a bad thing. However, concentration is troublesome for investors who think they’re getting exposure to a more companies and larger portion of the market than they are.
“ARKK’s concentrated exposure to Tesla is a prime ETF example,” Rosenbluth said. “ARKK has been toward the top or the bottom of calendar year performance lists over the last 5 years.”
Tesla has a 14.9% weight in the ARK Innovation ETF (ARKK ). The fund is notably volatile, returning 67.6% in 2023 but plummeting 67.0% in 2022. The fund is down nearly 9% year to date through July 15.
“While the trend can often be your friend in investing, it is hard for stocks to repeat success as the bar is raised higher by investors,” Rosenbluth added.
For more news, information, and analysis, visit VettaFi | ETFDB.
