The S&P Dow Jones Indices (S&P DJI) is updating how it manages the weight of companies in its Select Sector indexes, effective Sept. 23, according to a company press release. The changes come as large tech companies have grown to dominate certain sector indexes.

These Select Sector indexes serve as the foundation for many popular ETFs. According to Morningstar Direct, 42 ETFs with a combined $303.6 billion in assets track these indexes, affecting numerous investor portfolios.

Hamish Preston, head of U.S. equities at S&P Dow Jones Indices, explained in a company blog post that the changes were necessary due to recent market trends.

"The rationale for the change to the capping mechanism is that the impact of market dynamics could result in the Legacy Capping Mechanism causing 'flip flops' in index weights," Preston wrote.

The current methodology aims to prevent a small group of companies from dominating an index. If a company with weights about 4.8% collectively exceeds 50% of the index weight, the smallest company in that group has its weight reduced to 4.5%, according to the S&P DJI announcement.

However, this approach led to unexpected outcomes, particularly in the Technology Select Sector index. Preston noted that in June 2024, Microsoft, Apple and Nvidia’s combined weight exceeded 50%, causing significant weight adjustments.

New Rules for S&P Sector Indexes

The new approach, called the “New Capping Mechanism” by S&P DJI, will handle such situations differently. The announcement states that the total weight of large companies will be reduced to 45%, with individual weights determined by their relative sizes after checking for any breaches in single-company limits.

This change is especially relevant for the $69 billion Technology Select Sector SPDR Fund (XLK), which tracks the Technology Select Sector index.

Morningstar analyst Zachary Even reported that under the old rules, the ETF “was forced to sell roughly $10 billion of Apple and buy nearly as much of Nvidia” during its June rebalance.

S&P DJI stated that the new method is designed to better maintain the relative sizes of companies in the index while still following diversification rules. This approach aims to reduce dramatic shifts in company weights within the indexes.

The Technology Select Sector index has generated growth in recent years, driven by the performance of its largest holdings. According to Morningstar Direct data, as of the June rebalance, Microsoft held a 22.13%, followed by Apple at 21.94% and Nvidia at 6.02%.