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Massive $71B ETF Reshuffle Approaches as Nvidia Overtakes Apple
(Bloomberg) — One of the world’s most prominent technology ETFs appears poised for a major rebalancing that would increase exposure to Nvidia Corp.NVDA) at the expense of Apple Inc.AAPL) – stimulating billions of dollars in trading volume at once.
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Barring an 11th-hour deviation from the methodology established by index provider S&P Dow Jones Indices, State Street Global Advisors is on track to revamp the composition of its $71 billion Technology Select Sector SPDR fund (XLK) after Nvidia’s market cap closed above Apple’s on Friday.
For months, XLK has held far fewer shares of Nvidia, even as the AI giant is up 166% year-to-date. When the chipmaker ranked third, it represented about 6% of the ETF’s assets, compared with 22% in the S&P 500 Information Technology Index. The ownership limit, imposed by diversification rules, meant that XLK would have massively underperformed this year.
While S&P theoretically reserves the right to make an exception, industry participants say the ETF is on track to be overhauled when it approves quarterly rebalancing near the end of June.
On that basis, Apple and Nvidia are expected to reverse their positions in the ETF, with the former’s weight falling to 4.5% and the latter rising above 20%, according to calculations sent by the index provider to three participants of the market familiar with the subject.
State Street plans to buy $11 billion in Nvidia shares and dump $12 billion in Apple, an estimate shows. This is not insignificant – the predicted sale of Apple shares is equal to the average daily trading value over the last three months.
“By our calculations, there will be a turnaround between Nvidia and Apple,” said Chris Harvey, head of equity strategy at Wells Fargo Securities. “This aligns the XLK ETF more closely with momentum trading and semifinals. At the margin, it’s more dollars chasing a stock that doesn’t need additional help.”
An S&P spokesperson declined to comment on possible changes to the index and referred Bloomberg News to the methodology.
Matt Bartolini, head of SPDR Americas Research at State Street, said XLK will be rebalanced according to its rules and methodology. The ETF is required to track the S&P benchmark which is designed to remain compliant with diversification regulations.
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The rules “have served investors well,” he said.
S&P left the door open to making an exception when releasing sector weights at the end of the month, judging by a document sent late last week and seen by Bloomberg News.
The index committee “reserves the right to make exceptions when applying the methodology if necessary,” S&P wrote in a note about the June rebalancing. “In any scenario in which treatment differs from the general rules contained in this document or supplementary documents, customers will be notified whenever possible.”
S&P said it will send clients so-called pro forma documents related to the rebalancing of sector indexes every day through Friday.
Any last-minute deviation from the public methodology would not be well received by traders, who tend to take positions in anticipation of possible revisions to index rebalances like this. Although it’s getting crowded, buying stocks that are entering the major indices and selling those that are leaving them has become one of the most reliable strategies for the hedge fund world.
Behind the huge adjustments to the pair’s ETF weightings are diversification rules dating back more than 80 years that were established to protect investors from concentrated bets. Under these rules, the combined representation of the largest companies – those that make up about 5% or more of a diversified fund – cannot amount to more than 50%.
Similar restrictions last year spurred the Nasdaq 100 overseer to carry out a special rebalancing to keep funds that track the index in compliance with the rules. When this rule is violated, indices like the Nasdaq 100 tend to proportionally reduce top holdings. The XLK methodology works differently. When multiple stocks are not in compliance, the smallest one is cut.
This single rule is why Nvidia has been massively under-owned by XLK, leading the fund to trail the traditional S&P 500 technology sub-index by more than 5 percentage points this quarter – the widest dispersion since 2001.
With the semiconductor pioneer reaching the size of Apple and Microsoft Corp. In recent weeks, upcoming XLK rebalances have drawn interest from Wall Street, given the prospect of volatility-inducing additions and deweightings for some of the world’s most closely watched technology companies.
“I’m interested to see if they keep the same rules until the next rebalance in September,” said James Seyffart, ETF analyst at Bloomberg Intelligence. “If Apple manages to overtake Nvidia or Microsoft by the next rebalancing reference date – which is September 13th – we could have a massive mirror image rebalancing where Apple is bought worth billions and Nvidia or Apple is sold worth billions. ”
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