Top ETFs or reallocations of over $100 billion will flow from Apple to NVIDIA

According to Zhitong Finance, one of the world's most well-known technology ETFs seems to be preparing for a major adjustment, increasing its exposure to NVIDIA Corporation (NVDA.US) while reducing its exposure to Apple Inc. (AAPL.US), potentially shifting billions of dollars in trading volume from Apple to NVIDIA.

After NVIDIA's market value surpassed Apple's, State Street Global Advisors is set to adjust the composition of its $71 billion Technology Select Sector SPDR Fund (XLK.US). Matthew Bartolini, Head of SPDR Americas Research, told the media that the new allocation shows that Microsoft (MSFT.US) will remain the top stock, followed by NVIDIA, and then Apple. Bartolini stated that XLK will rebalance according to its rules and methodology. ETFs are obligated to track benchmark indices designed to comply with diversification regulations. He said these rules "are beneficial to investors."

XLK, which focuses on technology stocks, is issued by SPDR, a division of State Street Global Advisors responsible for ETF business. Currently, XLK has assets under management (AUM) exceeding $71.2 billion, making it the second-largest fund under SPDR, only behind the $534.8 billion SPDR S&P 500 ETF (SPY.US).

Over the past few months, XLK has significantly reduced its holdings of NVIDIA stock, despite the AI giant's 166% surge year-to-date. When this chipmaker ranked third in market capitalization, its weight in the ETF's assets was about 6%, compared to 22% for the S&P 500 Information Technology Index. Due to the holding limit set by diversification rules, XLK's performance has lagged significantly this year.

While the S&P theoretically retains the right to make exceptions, industry insiders indicate that the ETF will readjust its holdings around the end of June during the quarterly rebalancing. Based on calculations provided by the index provider to three informed market sources, Apple and NVIDIA will change their positions in the ETF, with the former's weight decreasing to 4.5% and the latter's weight increasing to over 20%.

It is estimated that State Street Bank will purchase $11 billion worth of NVIDIA shares and sell $12 billion worth of Apple shares. This is not insignificant - the expected reduction in Apple shares is equivalent to its average daily trading value over the past three months. Chris Harvey, head of stock strategy at Fuguo Securities, said: "According to our calculations, a 'defection' between NVIDIA and Apple is likely to occur. This will further link the XLK ETF with momentum trading and the semiconductor market. From a marginal perspective, more dollars are chasing a stock that doesn't need any additional help."

According to a document issued late last week, it is still possible for S&P to make an exception when announcing industry weights at the end of the month. In a report on the June rebalancing, the Index Committee of S&P wrote that they "reserve the right to make exceptions when necessary to apply this method." "In any case, if the handling deviates from the general rules specified in this document or supplementary documents, clients will be notified as soon as possible."

S&P stated that they will send so-called formal documents related to industry index rebalancing to clients every day before Friday. Any last-minute deviation from the public method will not be accepted by traders, who tend to build positions in anticipation of possible corrections in index rebalancing. Although the market is becoming more crowded, buying stocks entering major indices and selling stocks exiting these indices has become one of the most reliable strategies in the hedge fund industry.

Supporting the significant adjustment of the weights of these two companies in ETFs can be traced back to the diversification rules established over 80 years ago, which were set up to protect investors from concentrated bets. According to these rules, the total holdings of the largest companies (i.e. those with a share of 5% or more in a diversified fund) cannot exceed 50%.

Last year, similar restrictions prompted regulators of the Nasdaq 100 index to conduct a special rebalancing to ensure compliance with the rules by index tracking funds. When this rule is broken, indices such as the Nasdaq 100 often proportionally reduce holdings of top stocks. XLK takes a different approach. When many stocks do not meet the requirements, the stocks with the smallest proportion are cut.

This unique pattern is the reason for XLK's significant reduction in NVIDIA, causing the fund to lag behind the traditional S&P 500 tech sector index by over 5 percentage points this quarter - the largest gap since 2001. **As NVIDIA's market value has caught up with Apple and Microsoft in recent weeks, and with the possibility of fluctuations in the weights of some of the world's most watched tech companies, the upcoming adjustment by XLK has piqued Wall Street's interest Bloomberg ETF analyst James Seyffart said: "I am interested to see if they will keep the rules unchanged in the next rebalance in September. If Apple manages to surpass NVIDIA or Microsoft on the next reference date for rebalancing, which is September 13th, we may have a mirror image of a large-scale rebalance, with Apple being bought for billions of dollars, while NVIDIA or Microsoft being sold for billions of dollars."