XLK ETF Prepares for Major Shift: Buying Nvidia, Selling Apple in Quarterly Rebalancing

 

One of the biggest US technology ETFs is set to get a radical makeover this week.

The Technology Select Sector SPDR Fund is going to look very different after its quarterly rebalance on Friday. Because of the meteoric rise of chip giant Nvidia this year, and byzantine diversification rules, the process is likely to force XLK to buy billions of dollars' worth of Nvidia stock while significantly lightening its Apple position.

The Massive Rebalance is Happening (I'm pretty sure)," James Seyffart, an ETF Research Analyst at Bloomberg Intelligence, posted Friday. He estimated XLK would need to sell some $12.6 billion of AAPL shares and buy about $10.9 billion of NVDA shares at current prices. Confirmation is awaited from S&P/SPDR.

It should be trading closer to $153, $154, depending on where the S&P's at," Matthew Bartolini of State Street, head of SPDR America's Research, which manages XLK, said to CNBC in a comment that echoed Seyffart's math. S&P Global wouldn't comment on index changes.

What's Happened with XLK?

XLK tracks the Technology Select Sector Index, a group of stocks from S&P 500 companies in the Information Technology sector, totaling 65 stocks, including America's three most valuable companies: Apple, Microsoft, and Nvidia.

The fund is theoretically market-cap weighted, meaning companies with higher market values have more influence on the value and share price of the fund. However, to ensure proper diversification, no single security can be more than 25% of the fund. To ensure proper diversification in a fund, S&P Global caps each security's weight at 23%.

Nvidia's Rise Above Apple

For a very long time, Apple and Microsoft were the only stocks bumping close to their 23% cap. With Nvidia's supersonic trajectory over the last year and a half, there are now three companies in that index each sporting over $3 trillion in value—more than 60% of the index combined.

Initial ascendance by Nvidia seemed to fix the weighting problem because it raised Nvidia's share and cut Apple and Microsoft to less than 23%. A new rule states, "The sum of the companies with weights greater than 4.8% cannot be more than 50% of the total index weight." If they are, companies are ranked by market cap, and those with the smallest caps are cut back to a maximum of 4.5%.

The S&P is rebalanced quarterly—on the third Friday of March, June, September, and December—based on market caps of each stock from the previous week.

At the end of last week, following Nvidia to an above-Apple free-float-adjusted market cap, the index will have to reduce Apple exposure by almost 80%.

Any ETFs tracking this index will have to buy NVDA and sell AAPL to account for the capping difference," explained George Smith, Portfolio Strategist for LPL Financial.

Implications for Stocks

The stakes are enormous for shareholders of both firms. Although XLK is a large fund in its own right, rebalancing might affect other funds that follow the same index. Even if XLK is acting alone, its portfolio adjustments can have huge implications for the largest technology stocks.

This can press on its price, especially when buying or selling billions of dollars in a single stock in one week. However, the boost to come to Nvidia's stock through rebalancing could be dampened by the previous week's stock split that increased the number of outstanding Nvidia shares.

On the other hand, the system could be pressured or the stock price weakened by a large, sudden supply of Apple shares that XLK offloads.