Is VGT sufficiently diversified?

[carloslando]

I wanted a bit of Tech tilt and have been investing in VGT in addition to VTSAX/VTI.
Was surprised to see a 3.5% move in its price overnight.

Looking at its top 3 holdings (Apple - 23%, Microsoft - 20%, Nvidia - 6%):
1. NVIDIA's dramatic pop in price (up ~25% overnight) seems to be the main reason for this somewhat significant move.
2. Of 364 stocks in this ETF just the top three holdings are now 50% of the portfolio

Which makes me wonder: is VGT sufficiently diversified or too dependent on these top 3 names now?

Are there alternate tech-tilted ETFs that I should consider? Fidelity's Cloud Computing ETF (FCLD) seems to be an option but has'nt been around long enough for me to be comfortable about its management.


Edit: I responded to some of your questions in a post later in this thread: viewtopic.php?p=7284559#p7284559

[arcticpineapplecorp.]

I wanted a bit of Tech tilt and have been investing in VGT in addition to VTSAX/VTI.
Was surprised to see a 3.5% move in its price overnight.

how much of a tilt is VGT in your portfolio?

For instance if you hold 10% in VGT then didn't that 3.5% in VGT only cause a 0.35% increase in your portfolio? (of course taking out the effect the three companies you mention also had on VTSAX/VTI as well).

But this begs the question...

these three companies you're worried about are already in VTI/VTSAX, according to market cap weighting.

you are not owning different companies, just in different weights than the market.

1. do you have a good reason of doing this? I.E., do you know something the market doesn't?

2. you seem fearful of the move of your tilts. You can say it's just the fund seems not well diversified but you wanted a tilt. So how much movement were you expecting (but not more than that)? If it's too much movement for you, then you probably shouldn't tilt, right? Or reduce your tilt, right? If you hold 10% VGT maybe you should hold 5% knowing that some would argue if you're holding 5% or less in anything it's not likely to move the needle either way, so why bother?

[Hyperchicken]

Sufficiently for what?

[alex_686]

Define “diversified”.

I an sure from a regulatory it meets the requirements.

Any other definitions you want to use?

A common one is looking at the correlations between the individual stocks and the volatility of the portfolio.

I have lengthy debates with my co-workers on thus subject. They all have Masters of Financial Math.

[secondopinion]

I wanted a bit of Tech tilt and have been investing in VGT in addition to VTSAX/VTI.
Was surprised to see a 3.5% move in its price overnight.

Looking at its top 3 holdings (Apple - 23%, Microsoft - 20%, Nvidia - 6%):
1. NVIDIA's dramatic pop in price (up ~25% overnight) seems to be the main reason for this somewhat significant move.
2. Of 364 stocks in this ETF just the top three holdings are now 50% of the portfolio

Which makes me wonder: is VGT sufficiently diversified or too dependent on these top 3 names now?

Are there alternate tech-tilted ETFs that I should consider? Fidelity's Cloud Computing ETF (FCLD) seems to be an option but has'nt been around long enough for me to be comfortable about its management.

See this (which applies to most ETFs):

Under the current US Internal Revenue Code, among other things, a fund needs to satisfy certain tests, such as those relating to asset diversification and sources of income, for qualification as a "regulated investment company" or "RIC". More specifically, one requirement of a RIC is that at the end of each quarter of a RIC’s tax year no more than 25% of the value of the RIC's assets may be invested in a single issuer and the sum of the weights of all issuers representing more than 5% of the fund should not exceed 50% of the fund’s total assets.

So, the worst case is a 50/50 sub-portfolio of two highly weighted-stocks (each at 25%) and at least ten lightly-weighted (no more than 5%) stocks. Right now, the top two are 43%; so, you are almost at the worst case already.

Nvidia is not a problematic stock in this fund in all honesty.

[martincmartin]

I wanted a bit of Tech tilt

Why do you want tech tilt? Is it because tech has been doing better than the overall stock market since 2015 or so? This is performance chasing. It could be like investing in real estate in 2007 or investing in ... tech in 1999.

Is it because tech is where a lot of innovation comes from that will power the economy? Like ChatGPT? That information is available to everyone, and already priced in. In other words, the reason why the price to earnings ratios of tech firms are higher than other firms is because they already expect tech firms to deliver more value in the future. So when you buy now, if they do deliver the expected value, you won't make any more money than just buying the market.

In fact, Warren Buffet made his billions doing the exact opposite. Because new and shiny companies get people excited, they may actually bid up the price to higher than is reasonable. Buffet looked for boring companies in old sectors whose P/E ratio was lower than fundamentals would suggest, as these didn't have a hype premium.

[alluringreality]

From the prospectus:

Nondiversification risk, which is the chance that the Fund’s performance may be hurt disproportionately by the poor performance of relatively few stocks or even a single stock. The Fund is considered nondiversified, which means that it may invest a greater percentage of its assets in the securities of a small number of issuers as compared with diversified mutual funds. Because the Fund tends to invest a relatively high percentage of its assets in its ten largest holdings, fluctuations in the market value of a single Fund holding could cause significant changes to the Fund’s share price. Nondiversification risk is expected to be high for the Fund.

Principal Investment Strategies
The Fund employs an indexing investment approach designed to track the performance of the MSCI US Investable Market Index (IMI)/Information Technology 25/50...

What does the “25/50” in the name of the index mean?
To qualify for favorable tax treatment under the Internal Revenue Code (the Code), an investment company must, among other things, meet certain diversification standards under the Code. Those standards require an investment company to invest no more than 25% of its assets in any one security and at least 50% in securities that each represent no more than 5% of the fund’s assets. The 25/50 in the name of the index denotes that the index’s construction rules take into account the diversification standards for investment companies covered under the Code.

The 25/50 indexes were adopted by Vanguard Sector Index Funds on February 26, 2010. Prior to that date, some of the Funds’ former indexes became so concentrated that funds replicating them would have failed the Code’s diversification standards. To ensure that this did not happen, some of the Funds’ portfolios differed significantly from the composition of the target indexes, leading to considerable tracking error. By adopting the 25/50 indexes, the Funds can better achieve their objectives of tracking their target indexes while continuing to provide exposure to the relevant market sectors.

Note that although Vanguard Sector Index Funds continue to comply with the diversification standards of the Code, each Fund still invests a high percentage of assets in a small number of issuers and thus will not comply with the diversification standards of the Investment Company Act of 1940. Consequently, each of the Funds is subject to nondiversification risk, which is the chance that a Fund’s performance may be hurt disproportionately by poor performance of relatively few stocks or even a single stock.

[nisiprius]

I don't think the question is whether VGT itself is diversified. The question is whether it is diversifying your whole portfolio.

And as far as I'm concerned, no, not much. Not everyone likes correlations as a measure of diversification, but at least it's a measure, and if we look at the correlations between an S&P 500 fund, and four different choices of "tech" (QQQ is only 50% tech and I don't want to go down that rabbit hole right now, but it is often considered an example of "tech"), we see:

Source



Regardless of exactly what kind of "technology" they are investing in--the pure technology sector (VGT), the tech-heavy but half other sectors Nasdaq (QQQ), "select" technologies (XLK), or "exponential" technologies--they have correlations of 0.92 with the S&P 500; that is, they are 92% similar to the S&P 500. And they are all similar to each other. The lowest number on the whole chart is 0.89.

[PoorHomieQuan]

Vanguard would recommend VUG or MGK rather than a "tech" specific ETF if you want a tilt. There's no very good definition of "tech" anyway (VGT doesn't include Google or Amazon, for example).

[retiredjg]

No. It is not very diversified. But more importantly, consider Nisi's question about whether it diversifies your portfolio.

If you want to diversify your portfolio, I don't think this is the way to do it. It's nothing more than a gamble on a sector that is already well represented in the total market.

I would not overweight tech and people who tend to do this seem to be in the tech field...making both their income and their nest egg dependent on a limited portion of the market. Not a wise move in my opinion.

[asset_chaos]

Which makes me wonder: is VGT sufficiently diversified or too dependent on these top 3 names now?

No, VGT is explicitly non-diversified. Did you overlook the list of fund risks? One of the specific risks listed for VGT is (underlining mine)

Nondiversification risk: The chance that the fund’s performance may be hurt disproportionately by the poor performance of relatively few stocks or even a single stock. The fund is considered nondiversified, which means that it may invest a greater percentage of its assets in the securities of a small number of issuers as compared with other mutual funds. Because the fund tends to invest a relatively high percentage of its assets in its ten largest holdings, fluctuations in the market value of a single fund holding could cause significant changes to the fund’s share price. Nondiversification risk is expected to be high for the fund.

The last underlined sentence says it all: "Nondiversification risk is expected to be high for the fund". And it's not Vanguard putting in some boilerplate to cover their behinds; the SEC has criteria to define whether a fund is diversified or not, and VGT does not meet the SEC definition of diversified. You're experiencing what you should have expected: this sector fund is not diversified. Although I haven't checked, I suspect every other technology sector fund is also non-diversified.

As you take on extra risks with a sector fund---risks over and above the risk of a total market fund---you have to be certain you have a high quality and high conviction answer to the question, what am I getting for accepting extra risk?

[arcticpineapplecorp.]

Which makes me wonder: is VGT sufficiently diversified or too dependent on these top 3 names now?

No, VGT is explicitly non-diversified. Did you overlook the list of fund risks? One of the specific risks listed for VGT is (underlining mine)

Nondiversification risk: The chance that the fund’s performance may be hurt disproportionately by the poor performance of relatively few stocks or even a single stock. The fund is considered nondiversified, which means that it may invest a greater percentage of its assets in the securities of a small number of issuers as compared with other mutual funds. Because the fund tends to invest a relatively high percentage of its assets in its ten largest holdings, fluctuations in the market value of a single fund holding could cause significant changes to the fund’s share price. Nondiversification risk is expected to be high for the fund.

The last underlined sentence says it all: "Nondiversification risk is expected to be high for the fund". And it's not Vanguard putting in some boilerplate to cover their behinds; the SEC has criteria to define whether a fund is diversified or not, and VGT does not meet the SEC definition of diversified. You're experiencing what you should have expected: this sector fund is not diversified. Although I haven't checked, I suspect every other technology sector fund is also non-diversified.

As you take on extra risks with a sector fund---risks over and above the risk of a total market fund---you have to be certain you have a high quality and high conviction answer to the question, what am I getting for accepting extra risk?

excellent response.

[carloslando]

Thank you all for the responses, this was very educational.

@assert_chaos, @alluringreality:
I did not realize VGT already called out its lack of diversification, thanks for highlighting that.

@retiredjg, @nisiprius
VGT is <10% of my portfolio, so yes from my overall portfolio perspective it does not particularly diversify me: most of my holdings are SP500/VTI so there is significant overlap

@martincmartin:
Yes I am basically chasing performance with this investment in VGT. I work in tech industry and believe over the next 10-15 years there will still be enough innovation in this space beating returns of the SP500. I just dont know who the exact winners will be so dont want to pick individual stocks. ie. whether its Mastercard or Visa that ends up leading the next wave of currency digitization, or, MongoDB or Snowflake or Oracle etc for databases, or Broadcom or Qualcomm for communication chips, or Nvidia or AMD for AI chips etc. So am looking for something in this 'sector' to 'juice up' my returns a bit.

Re-reading this thread I see with my current allocation I am not gaining that much of a benefit, either I have to make this a lot more significant part of my portfolio, or just go back to the simpler total-market/SP500 index funds I have, and not try getting this potential 'boost'.

[BitTooAggressive]

No. It is not very diversified. But more importantly, consider Nisi's question about whether it diversifies your portfolio.

If you want to diversify your portfolio, I don't think this is the way to do it. It's nothing more than a gamble on a sector that is already well represented in the total market.

I would not overweight tech and people who tend to do this seem to be in the tech field...making both their income and their nest egg dependent on a limited portion of the market. Not a wise move in my opinion.

Agree. Well said.