Checking under the hood: a deeper look at ETF holdings
Craig Swistun
Portfolio Manager
Lexicon Financial Group of Raymond James Investment Counsel
One of the core tenets of our investment philosophy is to remain broadly diversified and to keep costs low, wherever possible. Rather than purchasing individual stocks to build diversified portfolios, we gain exposure to sectors, geographic regions, or industries for investors through low-cost Exchange Traded Funds (ETFs).
An ETF is a single security that contains a broad spectrum of individual holdings. This reduces the impact any single stock can have on overall performance. By indirectly owning dozens or even hundreds of individual stocks, investors have instant exposure to an entire market segment, which helps smooth out volatility, reduces company-specific risk, and keeps costs low. Further, ETFs are among the most liquid investments currently available. It’s no surprise that ETFs have become one of the most widely-used tools among professional and institutional money managers.
In short, ETFs are an attractive long‑term tool for managing investment assets.
But choosing which ETF to include in an investment portfolio still requires due diligence, care and consideration. That’s because even though at first glance two ETFs within the same category may appear interchangeable, a closer look may reveal significant differences. And, it’s important to understand those differences before investing on behalf of clients. It’s not an option.
One of these things is not like the other
Two ETFs with nearly identical labels can have meaningfully different construction methodologies, concentration levels, and diversification characteristics. Fortunately, we have the tools to evaluate this before making a decision.
We can illustrate this perfectly by comparing two of the most popular technology sector ETFs: XLK: Technology Select Sector SPDR Fund and VGT: Vanguard Information Technology ETF. For transparency, we currently do not own either of the ETFs in client portfolios.
Both of these ETFs clearly target the technology industry, although a deeper look will reveal distinct approaches. Further, they are both offered by leading and well-respected ETF providers. So how do you choose?
XLK vs. VGT: Same Category, Different Engines
If we look at a side-by-side comparison, they look mostly the same.
| XLK | VGT | |
| Category | Technology Equities | Technology Equities |
| Index | S&P Technology Select Sector Index | MSCI US IMI 25/50 Information Technology |
| Expense Ratio | 0.08% | 0.09% |
| Issuer | State Street | Vanguard |
| Inception Date | December 16, 1998 | January 26, 2004 |
| Assets Under Management | $93.6 billion | $114 billion |
| Average Daily Volume (3 months) | 12,896,577 | 536,867 |
There are a few differences here worth noting. First, XLK has a longer track record, is slightly less expense, but is more widely traded than VGT. On the other hand, VGT has attracted more assets. It’s only when we analyse the underlying holdings that we start to see a major difference between how these two ETFs are constructed.
| XLK | VGT | |
| Number of Holdings | 72 | 323 |
| Top 10 Concentration | 61.1% | 41.3% |
| Percentage of holdings in large-cap companies | 99.8% | 88.7% |
XLK is significantly more concentrated. It holds 72 underlying stocks versus 323 for VGT. In addition, over 60% of the portfolio is invested in the top ten holdings and almost the entire portfolio is invested in large-capitalization companies. On the other hand, VGT provides exposure to medium- and smaller-sized companies and is less concentrated.
If you wanted to increase portfolio exposure to larger-sized technology companies, XLK might be a better option than VGT. However, if you want broader exposure to the sector, VGT might be the better option. The answer as which one you should choose depends on what your unique investment objectives and how the investments you select work together.
Putting it all together
As a portfolio manager that upholds a fiduciary standard, we are required to conduct this level of due diligence and analysis on any investment we make. Understanding what goes on “under the hood” is important. Before making an adjustment, we want to know precisely what role each holding in a portfolio is playing and how it supports overall client objectives.
Even though both ETFs are “technology funds”:
Risk profiles differ.
More concentrated funds like XLK may see sharper swings tied to mega-cap performance.Return drivers differ.
VGT’s inclusion of mid- and small‑cap names introduces more growth-oriented companies.Correlation isn’t 100%.
The two funds track different indices, with different methodologies and inclusion rules.
On the surface, ETFs grouped in the same category may seem identical. But a simple labels can may obscure significant variations in:
concentration risk,
diversification,
index methodology,
market-cap exposure,
and subsector weightings.
The XLK vs. VGT comparison is just an example—two technology ETFs that will behave differently because they are constructed differently. Looking under the hood is prudent. It’s keeps the investment engine running more smoothly, increasing the ability to reach the investment destination.
Craig Swistun is Portfolio Manager with Lexicon Financial Group (www.lexiconfinancialgroup.com) at Raymond James Investment Counsel.
The opinions expressed are those of Craig Swistun and not necessarily those of Raymond James Investment Counsel which is a subsidiary of Raymond James Ltd. Statistics and factual data and other information presented are from sources believed to be reliable but their accuracy cannot be guaranteed. It is furnished on the basis and understanding that Raymond James is to be under no liability whatsoever in respect thereof. It is for information purposes only and is not to be construed as an offer or solicitation for the sale or purchase of securities. Raymond James advisors are not tax advisors and we recommend that clients seek independent advice from a professional advisor on tax-related matters.