Apple + Dow Jones = Better Apple Exposure (Part 1)

Matt Thalman - Contributor - ETFs

On February 20, I wrote an article discussing how a number of ETFs were massively overweight Apple Inc. (AAPL), leaving investors with too much exposure to the world's largest company. While I believe Apple is a wonderful company to own, as I am a shareholder, unknowingly investors could very easily be overly exposed to just one company. If you are buying an ETF, mutual fund or index fund it is likely because that one purchase diversifies your investment. But because these funds are so overweight Apple, you may not be as diversified as you may think. Luckily though, the announcement that Apple will join the Dow Jones Industrial Average is sign that investors will have the ability to still buy index funds and not have to worry about being overly exposed to Apple.

Before we get into why Apple joining the Dow is a good thing, let's discuss why Apple is so overweight in different funds available.

The wide majority of mutual funds, ETFs, or simply investors in general, measure their yearly performance by comparing it to the performance of the S&P 500, I have even recommended this. For mutual fund or ETF managers the issue arises from this because they need to have their portfolios perform similar to the S&P 500, or clients will begin defecting from their fund to find greener pastures, in most cases a fund manager who has outperformed or at the very least matched the S&P 500 performance.

Therefore in order to perform as "the market" the fund manager's portfolio needs to have similar holding and or weightings as the broader index. (Here is where things may get confusing.) A stocks weighting in an index or fund is how much of a percentage of that fund the one stock carriers within a portfolio or index. For example; if you owned 10 stocks which were worth $100,000 and just one stock (we will call it xyz) was worth $55,000 while the others were worth $5,000 each, one stock would be worth 55% of your portfolio while the others would consist of just 5% of your investable assets.

The weight of xyz would have on your portfolio is massive and way out of proportion. If xyz stock were to fall in value by say just 10%, you would lose $5,500, more than anyone of your other investments are worth. Essentially your entire portfolio will live and die with that one stock. Now this is a very extreme case example, let's get back to reality.

In the article discussing investor's exposure to Apple, I highlighted different funds that had Apple claiming 4% of investable dollars, which made sense in some cases and others were Apple accounted for as much as 9.8% of the funds' assets, which didn’t really make sense as to why it was so much.

I believe the main reason most ETFs, mutual funds, the S&P 500 itself and the ETFs that track the index, such as the SPDR S&P 500 ETF (SPY) or the Vanguard S&P 500 ETF (VOO), are overweight Apple is due to the way these "pools" of stocks decide how much weight to give each stock. The S&P 500 determines the weight of each stock by company market capitalization. Therefore the larger the company, the more weight it has within the index. Apple, being the largest company in the world and almost doubling the second largest company, Exxon Mobil Corporation (XOM), carries 4.04% or double the weight of Exxon's 1.96%.

So with the case of the S&P 500, it is easy to see why Apple carries so much weight within the index, but does it still deserve that much power? Over the past few years Apple has been crushing it, producing massive returns to investors and beating the market. Moving forward though, if Apple begins to falter, it is not just going to hurt individual Apple shareholders, but also those investors who own Apple through different mutual funds, ETF's or index funds.

Apple recently represented 4.04% of the S&P 500. The smallest weighted stock within the S&P 500 was Diamond Offshore Drilling Inc. (DO) which accounted for 0.01% of the S&P 500. Based on my calculations, Apple weighted more, or yielded the same amount of influence on the S&P 500 index as the smallest 112 of the 500 companies within the index. That means that if Apple stock has a bad 2015 it could take as many as 112 companies to compensate for Apple's declining share price in order to keep the S&P 500 at an even level.

To me, that is a very scary thought. Think of all the retirement funds, unknowing investors out there who own a fund which holds Apple at an overweight proportion to other companies that would be hammered if Apple had a bad year, or even worse, a few bad years.

Check back soon to read Part 2 of Apple + Dow Jones = Better Apple Exposure and find out why Apple joining the Dow may help you reduce your exposure to Apple while still gaining diversity.

Matt Thalman Contributor - ETFs

Disclosure: This contributor held positions in Apple at the time this blog post was published. This article is the opinion of the contributor themselves. The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. This contributor is not receiving compensation (other than from for their opinion.