ETF mechanisms and the risks of portfolio overlap

Exchange-traded funds (ETFs) function as pooled investment vehicles that trade on exchanges like individual shares. Their pricing is maintained through a creation and redemption mechanism involving authorized participants, who use arbitrage to align the fund's share price with the value of its underlying assets.

While ETFs offer perceived diversification, investors may face unintended concentration risks due to overlapping holdings. For example, a portfolio containing multiple ETFs—such as those tracking broad markets and the Nasdaq-100—can result in heavy exposure to U.S. equities and the technology sector. In such cases, a seemingly diversified collection of funds may actually rely on a small number of large technology companies to drive returns.