Most exchange traded funds passively track benchmark indices that follow a capitalization-weighted methodology. Consequently, some sector and broad market ETFs lean toward a handful of heavyweight stocks.
Passive ETFs track a basket of stock holdings from a benchmark index. However, in a traditional market-capitalization weighted index, large companies will have a heavier weighting in the index and related ETF.
“Investors holding too great a percentage of assets in one sector or in the stocks of one country could be in for a rude awakening if a market jolt strikes.” according to Morningstar‘s Adam Zoll. “Plus, you may already have exposure to the sector or region through other, more diversified funds in your portfolio, such with as a broad market index fund. But another, more hidden risk, involves ETFs that are highly concentrated in just a handful of stocks.”
While a high concentration in a couple of stocks may bolster an ETF if the large holdings are doing well, the holdings can put a drag on heavily concentrated ETFs during harder times.
According to Morningstar data, the iShares High Dividend ETF (NYSEArca: HDV) is the most concentrated non-sector, non-regional ETF, with 62.3% of its total allocations in the top 10 holdings. [ProShares Aristorcrats ETF Tracks Quality S&P 500 Dividend Payers]
HDV’s top holdings include AT&T (NYSE: T) 9.1%, Chevron (NYSE: CVX) 6.9%, Johnson & Johnson (NYSE: JNJ) 6.8%, Procter & Gamble Co. (NYSE: PG) 6.2%, Pfizer (NYSE: PFE) 6.1%, Verizon Communications (NYSE: VZ) 5.5%, Philip Morris International (NYSE: PM) 5.2%, Merck & Co (NYSE: MRK) 4.9%, Intel Corp. (NasdaqGS: INTL) 4.3% and Coca-Cola (NYSE: KO) 4.0%.