Friday’s S&P 500 and Nasdaq-100 rebalance may reflect concerns over concentration risk

It’s arguably the biggest stock story of 2023: a small number of giant technology companies now make up a very large part of big indexes like the S&P 500 and the Nasdaq-100. 

Five companies (Apple, Microsoft, Amazon, Nvidia, and Alphabet) make up about 25% of the S&P 500. Six companies (Apple, Microsoft, Amazon, Nvidia, Alphabet and Broadcom) make up about 40% of the Nasdaq-100. 

The S&P 500 and the Nasdaq are rebalancing their respective indexes this Friday. While this is a routine event, some of the changes may reflect the concerns over concentration risk. 

A ton of money is pegged to a few indexes 

Now that the CPI and the Fed meeting are out of the way, these rebalances are the last major “liquidity events” of the year, corresponding with another notable trading event: triple witching, or the quarterly expiration of stock options, index options, and index futures. 

This is an opportunity for the trading community to move large blocks of stock for the last gasps of tax loss harvesting or to position for the new year. Trading volume will typically drop 30%-40% in the final two weeks of the year after triple witching, with only the final trading day showing significant volume.

All of this might appear of only academic interest, but the big move to passive index investing in the past 20 years has made these events more important to investors. 

When these indexes are adjusted, either because of additions or deletions, or because share counts change, or because the weightings are changed to reduce the influence of the largest companies, it means a lot of money moves in and out of mutual funds and ETFs that are directly or indirectly tied to the indexes. 

Standard & Poor’s estimates that nearly $13 trillion is directly or indirectly indexed to the S&P 500. The three largest ETFs (SPDR S&P 500 ETF Trust, iShares Core S&P 500 ETF, and Vanguard S&P 500 ETF) are all directly indexed to the S&P 500 and collectively have nearly $1.2 trillion in assets under management. 

Linked to the Nasdaq-100 — the 100 largest non-financial companies listed on Nasdaq — the Invesco QQQ Trust (QQQ) is the fifth largest ETF, with roughly $220 billion in assets under management. 

S&P 500: Apple and others will be for sale. Uber going in 

For the S&P 500, Standard & Poor’s will adjust the weighting of each stock to account for changes in share count. Share counts typically change because many companies have large buyback programs that reduce share count. 

This quarter, Apple, Alphabet, Comcast, Exxon Mobil, Visa and Marathon Petroleum will all see their share counts reduced, so funds indexed to the S&P will have to reduce their weighting. 

S&P 500: companies with share count reduction

(% of share count reduction)

• Apple        0.5%
• Alphabet   1.3%
• Comcast    2.4%
• Exxon Mobil  1.0%
• Visa                0.8%
• Marathon Petroleum  2.6%

Source: S&P Global

Other companies (Nasdaq, EQT, and Amazon among them) will see their share counts increased, so funds indexed to the S&P 500 will have to increase their weighting. 

In addition, three companies are being added to the S&P 500: Uber, Jabil, and Builders FirstSource.  I wrote about the effect that being added to the S&P was having on Uber‘s stock price last week.  

Three other companies are being deleted and will go from the S&P 500 to the S&P SmallCap 600 index: Sealed Air, Alaska Air and SolarEdge Technologies. 

Nasdaq-100 changes: DoorDash, MongoDB, Splunk are in 

The Nasdaq 100-is rebalanced four times a year, however, the annual reconstitution, where stocks are added or deleted, happens only in December. 

Last Friday, Nasdaq announced that six companies would be added to the Nasdaq-100: CDW Corporation (CDW), Coca-Cola Europacific Partners (CCEP), DoorDash (DASH), MongoDB (MDB), Roper Technologies (ROP), and Splunk (SPLK). 

Six others will be deleted: Align Technology (ALGN), eBay (EBAY), Enphase Energy (ENPH), JD.com (JD), Lucid Group (LCID), and Zoom Video Communications (ZM).

Concentration risk:  the rules

Under federal law, a diversified investment fund (mutual funds, exchange-traded funds), even if it just mimics an index like the S&P 500, has to satisfy certain diversification requirements. This includes requirements that: 1) no single issuer can account for more than 25% of the total assets of the portfolio, and 2) securities that represent more than 5% of the total assets cannot exceed 50% of the total portfolio. 

Most of the major indexes have similar requirements in their rules. 

For example, there are 11 S&P sector indexes that are the underlying indexes for widely-traded ETFs like the Technology Select SPDR ETF (XLK). The rules for these sector indexes are similar to the rules on diversification requirements for investment funds discussed above. For example, the S&P sector indexes say that a single stock cannot exceed 24% of the float-adjusted market capitalization of that sector index and that the sum of the companies with weights greater than 4.8% cannot exceed 50% of the total index weight. 

At the end of last week, three companies had weights greater than 4.8% in the Technology Select Sector (Microsoft at 23.5%, Apple at 22.8%, and Broadcom at 4.9%) and their combined market weight was 51.2%, so if those same prices hold at the close on Friday, there should be a small reduction in Apple and Microsoft in that index. 

S&P will announce if there are changes in the sector indexes after the close on Friday. 

The Nasdaq-100 also uses a “modified” market-capitalization weighting scheme, which can constrain the size of the weighting for any given stock to address over-concentration risk. This rebalancing may reduce the weighting in some of the largest stocks, including Apple, Microsoft, Amazon, Nvidia, and Alphabet. 

The move up in these large tech stocks was so rapid in the first half of the year that Nasdaq took the unusual step of initiating a special rebalance in the Nasdaq-100 in July to address the overconcentration of the biggest names. As a result, Microsoft, Apple, Nvidia, Amazon and Tesla all saw their weightings reduced. 

Market concentration is nothing new

Whether the rules around market concentration should be tightened is open for debate, but the issue has been around for decades. 

Market concentration is nothing new: concerns over market concentration have been for around a long time. For example, Phil Mackintosh and Robert Jankiewicz from Nasdaq recently noted that the weight of the five largest companies in the S&P 500 was also around 25% back in the 1970s.

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