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'CHANDS': A Concentration Concern For Consumer Discretionary ETFs

March 21, 2018 2:44 pm
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Some of the primary concerns with cap-weighted funds, including exchange traded funds, include exposure to richly valued stocks and concentration risk. The issue of concentration risk as it pertains to cap-weighted ETFs can become particularly acute at the sector level, where a small number of stocks can dominate some marquee sector funds.

Concentration risk is often highlighted in the technology sector. For example, the Technology Select Sector SPDR (NYSE:XLK), the largest technology ETF by assets, allocates 14.1 percent of its weight to Apple Inc. (NASDAQ:AAPL) alone. Combined, Apple and Microsoft Corp. (NASDAQ:MSFT) account for over one-quarter of XLK's weight. Still, the weight attributed to the top five holdings in the S&P 500 Technology Index, including Apple and Microsoft, is not unusual.

“Which makes it important to notice that the present level of concentration is not unusual for the tech sector,” said S&P Dow Jones Indices. “By the 'top-five' measure, the S&P 500 Information Technology index is neither more, nor less concentrated than was typical over the past decade.”

Another Sector Of Concern

XLK's top five holdings account for about 42.5 percent of that ETF's weight. Similar weights to the top five stocks will be found with rival technology ETFs.

Technology is not the only sector-level offender for concentration risk.

As was highlighted here earlier this week, the consumer discretionary sector features concentration risk, much of it attributable to Amazon.com Inc. (NASDAQ:AMZN). The Consumer Discretionary Select Sector SPDR (NYSE:XLY) and rival cap-weighted discretionary ETFs often feature massive weights to Amazon, so much so that the e-commerce giant is usually triple the size of the next-largest holding in these funds.

“Concentration in the consumer discretionary sector, while less dramatic in absolute terms, is reaching unusual levels relative to recent history,” said S&P Dow Jones.

Not Just Amazon

Amazon is not the only reason concentration risk is on the rise in discretionary sector ETFs. The top five holdings in the S&P 500 Consumer Discretionary Index can be arranged into a nifty acronym: CHANDS, for Comcast Inc. (NASDAQ:CMCSA), Home Depot Inc. (NYSE:HD), Amazon, Netflix, Inc. (NASDAQ:NFLX) and Walt Disney Co. (NYSE:DIS).

“Just one issue (Amazon) presently accounts for over 21 percent of the sector, while the next four (Home Depot, Comcast, Disney and Netflix) account for another 23 percent,” said S&P Dow Jones.

Said another way, five of the 83 stocks in XLY combine for almost 45 percent of the fund's weight, sending concentration levels in the consumer discretionary sector to levels not seen in over 16 years.

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