One of the world’s biggest tech ETFs looks poised for a shake-up after Nvidia Corp. catapulted past Apple Inc. in size.

Thanks to diversification rules, the $67 billion Technology Select Sector SPDR Fund (ticker XLK) has held way fewer Nvidia shares for months now while the AI giant continues to soar. Currently, the chipmaker makes up roughly 6% of the fund’s assets, compared with 21% for the S&P 500 Information Technology Index — spurring XLK to underperform big time this year.

Now that Nvidia has raced past Apple in value, its ownership in XLK could undergo a drastic elevation when the ETF carries out a quarterly rebalance near the end of this month, according to Bloomberg Intelligence.

The ETF will reflect the full heft of the semiconductor pioneer’s capitalization — if Nvidia keeps its edge over Apple on Friday, the day when each XLK member’s preliminary representation is determined. In the process, Apple’s weight, currently at 21% of the fund, could drop to as little as 4.5%, thanks again to this diversification rule.

Such a shuffle could prompt XLK’s manager, State Street Global Advisors, to load up on Nvidia shares to the tune of $10 billion, Bloomberg calculations show. Meanwhile, the fund would need to dump around $11 billion of Apple shares. That’s not a petty transaction, particularly for Apple. Over the past three months, the stock has changed hands at a rate of $11 billion a day.

“If Nvidia is larger on the reference date, they will have to flip the weights and sell Apple,” said Bloomberg Intelligence analyst James Seyffart. “They will do whatever is required by the rules,” he added. “They were being forced to make even larger relative sales of a stock in the past.”

A State Street spokesperson said the firm will follow any revisions as set by the index methodology. A spokesperson for S&P Dow Jones Indices declined to comment on potential index changes and referred Bloomberg News to the methodology.

It’s the latest example of how the relentless rally in tech behemoths is pushing up against the limit of regulations that date back more than 80 years. Established to protect investors following the stock market crash and the Great Depression, the diversification rules can be punishing in a lopsided market.

At issue is a cap on how much a stock’s impact is allowed in XLK. While the fund is designed to mimic returns in the traditional S&P 500 tech sub-index over the long run, it tracks a version of the sector gauge that’s kept by S&P and follows the practice of limiting member weights to avoid violating diversification rules.

Similar restrictions last year spurred the overseer of the Nasdaq 100 to conduct a special rebalance to keep index-tracking funds in compliance with the rules. Under those rules, the combined representation of the largest companies — those making up roughly 5% or more of a diversified fund — can’t add up to more than 50%. 

When this rule is breached, indexes such as the Nasdaq 100 tend to trim the top holdings proportionally. XLK’s methodology works differently. When a number of stocks are not in compliance, the smallest of those gets clipped.

In the previous two quarterly rebalances, Nvidia’s weight in XLK was cut to 4.5% each time because its value trailed Microsoft Corp. and Apple, and was therefore more exposed to a reduction. That happened even as the chipmaker made up 17% of the regular S&P 500 tech index in March and 11% in December.

As a result, XLK suffered from not owning enough Nvidia, with the latter surging around 145% year-to-date amid the AI frenzy. The ETF has lagged behind the traditional S&P 500 tech gauge by 4.5 percentage points this quarter — on track for the widest dispersion since 2001.

Missing Out | XLK ETF fails to get all the upside in tech stocks due to ownership limit
In the event that a switch does happen, Chris Harvey, head of equity strategy at Wells Fargo Securities, is more focused at the implications on how XLK may fit in an investor’s portfolio.

“The potential switch of sizing up of Nvidia and sizing down of Apple would make a very significant characteristic change to XLK,” he said. “We will have an ETF that is more semis-oriented and more momentum-orientated. It is changing the characteristic, which means it may change the way the ETF trades.”

This article was provided by Bloomberg News.