A Case Study in Mismatched Fund Returns

magnifying glass over stock chart — (Image credit: Getty Images)

Over the past 12 months, the Technology Select Sector SPDR Fund (XLK) – a member of the Kiplinger ETF 20, our favorite exchange-traded funds – has returned a loss of 10.5%, lagging a 5.0% loss in the S&P 500 Information Technology Index.

Both the ETF and the index are weighted by market value and include the same companies – the 69 tech stocks that are members of the S&P 500 stock index. So, what gives?

Weighting matters when it comes to fund returns

The weighting of stocks in the ETF varies from their weighting in the index, thanks to a rule in the Investment Company Act, enacted in 1940, that governs how mutual funds and ETFs should maintain diversification.

From just $107.88 $24.99 for Kiplinger Personal Finance

Become a smarter, better informed investor. Subscribe from just ~~$107.88~~ $24.99, plus get up to 4 Special Issues

CLICK FOR FREE ISSUE

https://cdn.mos.cms.futurecdn.net/flexiimages/y99mlvgqmn1763972420.png

Sign up for Kiplinger’s Free Newsletters

Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.

Profit and prosper with the best of expert advice - straight to your e-mail.

"The index doesn't have to adhere to the 1940 Investment Company Act, but the fund does," says Matthew Bartolini, head of ETF research in the Americas for State Street Global Advisors.

The diversification rules are designed to avoid risk from stock concentration in funds.

Chiefly, the rules prescribe that no single stock can make up more than 25% of any given fund's assets and that the sum of any stocks in the fund with a 5% or greater stake must add up to less than 50%.

Ergo, Apple (AAPL), Microsoft (MSFT) and Nvidia (NVDA) – top holdings in both the Technology Select Sector ETF and the Information Technology index – make up 41% of the ETF but account for roughly 60% of the Info Tech index.

The variation in the weighting of holdings had little impact on relative returns in 2022 and 2023, when the ETF and the Info Tech index posted similar gains.

But 2024 was different, thanks to mega-size gains in a handful of mega-size companies. The ETF logged a 21.6% gain that calendar year; the Info Tech index, 36.6%.

"It has been an anomalous market," says Bartolini. Of course, many of those mega-size firms have given back some of those gains recently, and that may mean the ETF will close the gap in relative performance.

The Technology Select Sector SPDR is a solid tech fund. The ETF's 10-year 17.4% annualized return beat 89% of its peers.

This item first appeared in Kiplinger Personal Finance Magazine, a monthly, trustworthy source of advice and guidance. Subscribe to help you make more money and keep more of the money you make here.

Nellie joined Kiplinger in August 2011 after a seven-year stint in Hong Kong. There, she worked for the Wall Street Journal Asia, where as lifestyle editor, she launched and edited Scene Asia, an online guide to food, wine, entertainment and the arts in Asia. Prior to that, she was an editor at Weekend Journal, the Friday lifestyle section of the Wall Street Journal Asia. Kiplinger isn't Nellie's first foray into personal finance: She has also worked at SmartMoney (rising from fact-checker to senior writer), and she was a senior editor at Money.