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Be wary of 'concentration risks' in tech ETFs: Strategist

Tech ETFs saw massive inflows of over $17 billion last year, according to VettaFi. However, Financial Futurist Dave Nadig, says many are "overdone" in mega-caps like Nvidia (NVDA) and Meta (META) which drive gains. He warns of "concentration risks," noting that in the Technology Select Spdr Fund (XLK) just 5 names account for more than 50% of the fund.

Nadig advises those investing in tech to "look for strategies that are a little bit more equal-weighted." He suggests something like the Robo Global Robotics and Automation Index ETF (ROBO) which is "much more balanced" with global diversification across use cases.

Many tech ETFs have "hyper-concentrated" portfolios, with stocks like Microsoft (MSFT), for example, dominating the top holdings. On the days that dominate stock does well, "performance will beat everybody else," while down days see similar exaggerated moves. Nadig recommends focusing on long-term plays that "benefit over the cycle, not just over the headline."

Beyond tech, Nadig highlights healthcare as an attractive sector, suggesting the Simplify Healthcare ETF (PINK) for exposure without "veering entirely" into biotech/pharma - providing "nice balance."


For more expert insight and the latest market action, click here to watch this full episode of Yahoo Finance Live.

Editor's note: This article was written by Angel Smith

Video transcript

AKIKO FUJITA: Well, the recent rally in tech is extending to ETFs. Over the last 12 months, tech ETFs have seen $17 billion in inflows. That's at least according to our next guest. With investors focused on tech and innovations in AI, what are the strongest ways to position your portfolio? Let's bring in Dave Nadig, financial futurist.

He's joining us for our ETF report brought to you by Invesco QQQ. Dave, that number, $17 billion pretty staggering when you think about the outflows that you've highlighted. $17 billion in non-tech ETFs, what does that tell you about where the momentum is right now? And how much of that can continue?

DAVE NADIG: Yeah. It feels like this is a little overdone, to be honest. We've seen the giant rallies in stocks like Microsoft and Nvidia. And they've really driven not just the tech sector, but the S&P 500. They really are the stocks that are moving everything. And concentration risk is something we need to be really paying attention to, particularly with tech ETFs.

So as you said, $17 billion has flowed into tech sector ETFs. The big one there is XLK, the State Street select sector SPDR tech ETF. It's actually in a bit of a bind now because its top five holdings are actually more than 50% of the fund. That puts it in violation of what's called the 55 rule with the IRS.

They'll have to make some adjustments there and get some of those heavy weights down. So what do you do if you're an investor and you actually want to keep leaning into technology here? I would recommend that you look for strategies that are a little bit more equal weighted or at least mitigating some of that concentration so you're not 25% Microsoft, not 8% in Nvidia.

I'd highlight something like the ROBO Global robotics and automation ETF. The ticker there is R-O-B-O. This is a very specific thematic play in AI and robotics, which, let's be honest, has really been what's driving most of these tech headlines. There, you're getting a much more balanced, equal weight, sort of 80 to 85 stock portfolio. You're getting global diversification. So it's not just a handful of stocks.

And you're getting some of the use cases, not just the folk making the chips, but folks like Daifuku in Japan or Siemens in Germany that are actually taking what we're getting out of AI and putting it to work in American factories, global factories, logistics, transportation. That's where this is really going to make a difference in the economy is when we actually take some of this technology and get it to work.

AKIKO FUJITA: Dave, you know you're going to have investors out there though that say, it's kind of tough to part with the returns that we've been getting in these concentrated stocks. To what extent have you started to see that broaden out, the AI play?

DAVE NADIG: Well, the concentration issue is always going to be a bit of a performance conundrum because I mean, just look at the top of the tech stack right now. Microsoft is 23%, 25% of most big tech ETFs. Obviously, that means if Microsoft is having a good week, your performance is going to beat everybody else. But that's a bit of a canard. It's a bit of a mirage because obviously, it works exactly the same way on a down day.

So I'm generally never a fan of these hyper-concentrated portfolios. Look, if you want to own a ton of Microsoft, that's easy to buy too. Just go buy a ton of Microsoft. I really think that investors should be focused on longer term plays where you can find those companies and pockets of the economy that really benefit over the cycle, not just over the headline. So that's why I'd lean into something like ROBO Global. It's going to underperform on any day that Nvidia and Microsoft are the only story.

AKIKO FUJITA: Dave, we have admittedly been talking a lot about tech on this show. But you say the sector that everybody should be talking about is health care. What do you like there?

DAVE NADIG: Well, so health care has been interesting. It's the best performing of the S&P 500 sectors this year so far. And effectively, nobody's talking about it except for occasionally a few headlines about Ozempic. And that is one of the big stories. The GLP-1 drugs are a big story. Cancer research has really been taking off. And there's some great plays there.

I do think you need somebody with real expertise in the space. I think this is one of those corners of the market that's a little tough to index. I like Fun By Simplify. Their Simplify Health ETF it's called PINK, P-I-N-K. That's an actively managed fund run by a guy named Mike Taylor, who's a storied investor in the space.

He's run long short hedge funds in health care for years. And this is a fund where he's making very specific picks about where he thinks the market's going. And he's been beating the core indexes in health care very consistently since this fund launched in 2021. I think he's up-- over the last 12 months, he's been beating the core index by 3% or 4%.

So great track record so far. But more importantly, a really intentional portfolio that's getting you exposure to some of those more interesting biotech and pharma names without just veering entirely in that direction, but neither avoiding the more traditional health care plays either. So I think it gets you that nice balance.

Another little side benefit of PINK is that they donate all the profits to the Susan G Komen Foundation for cancer research. So you're kind of getting a double whammy there. You're not only going to get to profit from the advances we're making in that kind of research. You're also going to get to help out.

AKIKO FUJITA: Some good takeaways there as always. Dave Nadig, financial futurist, good to talk to you today. Appreciate the time.

DAVE NADIG: Thanks for having me.