Tech XLK Rebalancing

yogibearbull

Tech XLK Rebalancing

The next rebalancing of tech XLK may lead to a drastic change.

Its indexing rule limits the super-sized weight total to 50%, so MSFT and AAPL are super-sized now, but NVDA’s weight is clipped*, and everything else is capped under 5%. If NVDA continues to have market=cap bigger than AAPL, then NVDA would be super-sized (i.e. MSFT, NVDA would be super-sized), and AAPL would be clipped*. This would require selling $11.4 billion of AAPL and buying $9.8 billion of NVDA. Both being maga-caps, this may be just a ripple, or not.

Other tech ETFs do things differently and won't be affected by this change in XLK.

*This is a weird aspect of SPDR XLK indexing rule. More rational would be to proportionately reduce the super-sized weights, but XLK takes it all from the smallest of the group, now NVDA.

https://www.morningstar.com/etfs/arcx/xlk/portfolio
https://x.com/JSeyff/status/1800602335733059779
https://theedgemalaysia.com/node/715084

yogibearbull

With this AAPL rally, the market-cap ranks on 6/12/24 are: AAPL, MSFT, NVDA. If NVDA remains at 3rd place by Friday close, NOTHING unusual would happen on XLK rebalancing.

yogibearbull

On 6/13/24, market-cap ranks were AAPL, NVDA, MSFT. Would MSFT get the knife? One more day of this silly drama driven by weird XLK rebalancing rules.

6/14/24 close will determine the order, but rebalancing will happen a week later on 6/21/24.

BaluBalu

This is from a few minutes ago and i was surprised by the magnitude of change

https://www.cnbc.com/2024/06/17/nvidia-to-get-20percent-weighting-and-billions-in-investor-demand-while-apple-demoted-in-major-tech-fund.html

yogibearbull

This is the likely outcome that is also reported by M* and others,
https://www.morningstar.com/news/marketwatch/20240617132/popular-tech-etf-forced-to-dump-apple-stock-buy-nvidia-in-upcoming-rebalancing

Things were really close in Friday's finish. In fact, AAPL was ahead of NVDA in the market-cap, but SPDR uses free-floats for XLK, and there NVDA seems ahead. So, for example, Warren Buffett couldn't have helped out his buddy Tim Cook by buying a few billion worth of AAPL that he sold recently - because of his large AAPL position, his shares are no longer part of the free-float.

All these articles do hedge a bit because SPDR/S&P hasn't issued a formal press release yet (why not?). But this huge AAPL to NVDA shift in XLK will be all done by the coming Friday, 6/21/24.

IMO, SPDR/S&P should review its strange way of rebalancing - nobody else does it in this silly manner.

BaluBalu

@yogibearbull,

I am starting to notice that a lot of indices are free float adjusted in applying their primary criteria. That is like poring oil on fire and feeding further into prevailing retail sentiment. Is there an implication in the reverse also?

rforno

Relatedly, I'm a likely long-term buyer of INTC if (er when) it drops further should rumors be true that NVDA will replace it in the Dow.

NVDA seems more like a momentum stock these days, so not interested in it.

yogibearbull

The use of free-float in indexes is sensible as that is the float that is publicly available. So, excluded are restricted stock (held by executives, directors, connected entities, etc), closely-held stock (insiders, major holders), Treasury stock (buybacks that aren't cancelled). If total market-cap is used, then funds will try to buy many more shares than are publicly available, and that would create a problem.

Many recent IPOs offer extreme examples (ARM, Saudi ARMCO - in Middle Eastern markets, etc) where only a small % of market-cap is issued.

Most other funds use proportional adjustments when caps are encountered. For example, if 3 stocks are eligible to be counted in 50% limitation, and they have approximately the same free-floats, then 3X = 50, or X = 0.1667, or 16.67% weight for each may be used. But the XLK formula knocks down the smallest (even by the tiniest amount), so 2X + 4.5 = 50, or X = 0.2275, or the weights 22.75%, 22.75%, 4.5%. That is what will cause this massive shift as NVDA used to be #3, but now AAPL is #3.

https://corporatefinanceinstitute.com/resources/career-map/sell-side/capital-markets/free-float/
https://www.investopedia.com/terms/f/freefloatmethodology.asp

msf

excluded are ... Treasury stock (buybacks that aren't cancelled).

Treasury shares are usually not counted (in the US) even before making a free-float adjustment. This is because indexes start with outstanding stock and Treasury shares are not outstanding. (They're issued but not outstanding, due to the buyback.)

From S&P Global Index Mathematics Methodology:

Shares Outstanding. This is the given company’s shares outstanding and provides total company level shares, as reported by stock exchanges, company press releases, and financial documents. Treasury shares are excluded

https://www.spglobal.com/spdji/en/documents/methodologies/methodology-index-math.pdf

OTOH, S&P's Float Adjustment Methodology gives a much more detailed and nuanced description of what is and isn't included in free float. Regarding Treasury stock it notes:

Due to local reporting patterns in some markets, S&P Dow Jones Indices may include treasury shares in total shares outstanding but exclude them from float.

https://www.spglobal.com/spdji/en/documents/index-policies/methodology-sp-float-adjustment.pdf

What it means by "local reporting" is country by country. Some countries include treasury shares in their outstanding stock calculations, others don't. MSCI clarifies this somewhat:

For most countries, treasury shares are included in the determination of the total shares outstanding, and therefore MSCI includes them in the calculation of free float. In countries like United Kingdom, USA, Canada where treasury shares are excluded from the determination of the total shares outstanding, they are accordingly not included in the calculation of free float.

https://www.msci.com/index/methodology/latest/FreeFloatData (pdf)

Conceptually, yogi's first sentence says it all:
The use of free-float in indexes is sensible as that is the float that is publicly available.

If one cares about the nitty gritty, see pp. 3-4 of the S&P Float Adjustment Methodology doc. (FWIW, it's fairly short but still more than I care to know.)

BaluBalu

Good point on the liquidity issues if not adjusted for free-float. I guess liquidity is paramount for capital markets functioning.

I see heavy insider selling in some company shares for nearly year and no insider buying. I am also seeing hedge funds lightening up on some of the retail favored stocks. All these extra shares add to the free-float, which then impacts how much of the retail favored stocks are weighted in the index. (At least they are not doing it by trading volume.)

XLK methodology is a bit strange any way.

Let us see when Apple gets back what it is giving up in the index.

Derf

Does anyone in this thread own XLK & to what % of portfolio if held ?

yogibearbull

I don't own XLK, so that is 0.00% for me.

But I do hold LC-growth and MSFT, NVDA, APPL are top stocks in those funds.

These 3 are also top stocks in SP500 accounting for 20% of SP500.

So, this shift of about $11 billion in the next few days may have a notable effect on LC-growth and/or the market.

Posters are free to skip - XLK is in the title.

yogibearbull

SSGA is showing new weights for MSFT, NVDA, AAPL this morning. Other sites may not have updated.
https://www.ssga.com/us/en/intermediary/etfs/funds/the-technology-select-sector-spdr-fund-xlk