ETF diversification and concentration risks

Discussions regarding exchange-traded funds (ETFs) highlight the technical mechanisms of pricing through creation and redemption, while warning investors about the risks of unintended portfolio concentration.

While ETFs are intended to provide diversification, overlapping holdings across different funds can lead to heavy exposure to specific sectors, such as technology, or a small number of large-cap companies. For instance, combining broad market funds with sector-specific funds like the Nasdaq-100 may result in a portfolio that relies heavily on a few major U.S. equities.

To mitigate these risks, investment strategies suggest a simplified approach using a limited number of broad-access funds combined with regular quarterly rebalancing. Experts warn that holding multiple funds, such as a global ETF alongside an S&P 500 ETF, can create a “false sense of security” due to shared major holdings. In some cases, a portfolio may end up with significant dependence on just a few companies, such as Nvidia, Apple, and Microsoft.