Key Points
Investors often use sector ETFs to tilt their portfolios towards a specific theme.
In reality, most market-cap-weighted sector ETFs are simply bets on only a few companies within that sector.
Sector ETFs often feel like diversified portfolios built around a specific industry. You own dozens of companies to add exposure to the sector itself without trying to pick individual winners.
The problem is that most of them aren't actually built that way.
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Because the vast majority of them are market-cap-weighted, just a few stocks can dominate these ETFs. A lot of attention is paid to the top-heaviness of the S&P 500 and the tech sector because those companies are dominating the artificial intelligence (AI) trade right now.
In reality, tech doesn't even crack the top three sectors by concentration in the portfolio. That doesn't sound like diversification.
Image source: Getty Images.
11 S&P 500 sectors ranked by top three holding concentration
As it stands right now, here's the list of sectors ranked by their combined top three holding weight:
| Sector | ETF | Top 3 Holdings | Combined Weight |
|---|---|---|---|
| Consumer Discretionary | XLY | Amazon, Tesla, Home Depot | 44.7% |
| Communication Services | XLC | Alphabet, Meta Platforms, AT&T | 43% |
| Energy | XLE | ExxonMobil, Chevron, ConocoPhillips | 42.1% |
| Technology | XLK | Nvidia, Apple, Microsoft | 35.2% |
| Healthcare | XLV | Eli Lilly, Johnson & Johnson, AbbVie | 34.3% |
| Financials | XLF | JPMorgan Chase, Berkshire Hathaway, Visa | 30.8% |
| Utilities | XLU | NextEra Energy, Southern Company, Duke Energy | 27.8% |
| Real Estate | XLRE | Welltower, Prologis, Equinix | 27% |
| Consumer Staples | XLP | Walmart, Costco, Procter & Gamble | 26.7% |
| Materials | XLB | Linde, Newmont, Freeport-McMoRan | 25.3% |
| Industrials | XLI | Caterpillar, GE Aerospace, RTX | 18.6% |
Data source: State Street.
The State Street Consumer Discretionary Select Sector SPDR ETF(NYSEMKT: XLY) stands as the biggest offender. The trio of Amazon, Tesla, and Home Depot make up nearly 45% of the portfolio. But it's Amazon and Tesla that account for roughly 40% of it on their own. The concentration is actually worse than this table would indicate.
The State Street Communication Services Select Sector SPDR ETF(NYSEMKT: XLC) tells a pretty similar story. AT&T allocates only 5% to the number above. Meta Platforms and Alphabet account for the other nearly 40% of that weighting. This is another sector built mostly around just two stocks.
The State Street Energy Select Sector SPDR ETF(NYSEMKT: XLE) may be slightly more surprising. But it, too, is concentrated in just two stocks, ExxonMobil and Chevron, which account for 35% of the fund.
The State Street Technology Select Sector SPDR ETF(NYSEMKT: XLK) would only be considered slightly more diversified by comparison. Add Broadcom to the top three holdings listed above, and you've got roughly 40% of the portfolio accounted for.
Truthfully, there's a bit of a concentration problem in all of these sector ETFs. The big names carry the most influence, but you're not really getting the true sector exposure you might be looking for.
If you want an alternative, check out Invesco's suite of equal-weighted sector ETFs. You get the same basket of companies, but without the concentration problem inherent in the ETFs listed above.
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JPMorgan Chase is an advertising partner of Motley Fool Money. David Dierking has positions in Apple. The Motley Fool has positions in and recommends AbbVie, Alphabet, Amazon, Apple, Berkshire Hathaway, Broadcom, Caterpillar, Chevron, Costco Wholesale, Eli Lilly, Equinix, GE Aerospace, Home Depot, JPMorgan Chase, Meta Platforms, Microsoft, NextEra Energy, Nvidia, Prologis, RTX, Tesla, Visa, and Walmart. The Motley Fool recommends ConocoPhillips, Duke Energy, Johnson & Johnson, and Linde. The Motley Fool has a disclosure policy.
